Price limits and capital requirements of futures clearinghouses

Abstract Futures clearinghouses need capital to provide liquidity in case of default by clearing members. Price limits truncate observed futures prices and prevent observation of clearinghouses’ true default risk exposure. We show how to estimate the true default risk exposure from observed futures prices and model capital requirements using an option pricing model, which accounts for non-normality of and truncation in observed futures returns. We apply the model to the clearinghouse associated with the Winnipeg Commodity Exchange, compare required capital levels with actual capital levels and show that ignoring non-normality of futures returns causes overall capital requirements to be significantly underestimated.