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Working Paper
Portfolio Margining Using PCA Latent Factors
Filtered historical simulation (FHS)—a simple method of calculating Value-at-Risk that reacts quickly to changes in market volatility—is a popular method for calculating margin at central counterparties. However, FHS does not address how correlation can vary through time. Typically, in margin systems, each risk factor is filtered individually so that the computational burden increases linearly as the number of risk factors grows. We propose an alternative method that filters historical returns using latent risk factors derived from principal component analysis. We compare this method's ...