How to set the warning line and the liquidation line?

Stock pledge is a common form of financing in China's stock market. Since 2014, the scale of stock pledge of listed companies has started to grow rapidly, and by 2017, it has reached 7.2 trillion, accounting for about 13% of the total market value of listed companies. More data shows that by July 2017, up to 98.58% of the A-share market's stocks involve in stock pledges, which shows that the scope is wide and the scale is large.

I believe all investors can feel that the stock price fluctuation of listed companies is relatively large. Listed companies obtain financing through stock pledge, but if the stock price falls, the stock value can no longer bear the value of the loan, what to do?

Naturally, for collateral with large fluctuations in value, it is generally solved by setting a warning line and a liquidation line. When the stock value falls below the warning line, the listed company will be notified of additional stock or cash; when the stock value falls below the liquidation line, the equity will be forced to liquidate.

As mentioned above, the stock pledge market is already a very large and mature market, so the setting of the warning line and the liquidation line is actually relatively fixed. In general, the warning line for tradable stocks is 150%, the liquidation line is 130%; the warning line for restricted stocks is 160%, and the liquidation line is 140%.

How are these two lines determined? Of course, the specific values are determined based on long-term market experience. However, we also noticed that there is always a 20% difference between the warning line and the liquidation line. Why?

Generally speaking, from the listed company is notified to supply the collateral, to the disposal of the stock, the listed company will have 2 workdays to operate. After all, no one wants the liquidation to happen easily. If notifying in the morning, liquidating in the afternoon, the listed company will have no time to supply the collateral. We know that stocks in the Chinese stock market will never fall by more than 10% in one day due to the daily falling max limit, so this 20% is reserved for these two workdays. At least within these two workdays, the stock value will not fall below the liquidation line.

Therefore, when we study the cryptocurrency mortgage market, the same criteria should be followed in the setting of the warning line and the liquidation line. Specifically, the setting of the warning line and the liquidation line should play the following roles:

1. Decrease the probability that the collateral is forcibly liquidated By simulating historical data, the setting of the warning line and the liquidation line can ensure that when the collateral price falls below the warning line, it will not immediately fall below the liquidation line, thus leaving sufficient time for the borrower to supply the collateral, and allowing the order to continue normally.

2. Guarantee the principal and interest of the loaner The setting of the liquidation line can guarantee that when the price of the collateral falls below the liquidation line, it will not immediately fall below the sum of principal and interest of the loan, so that in the case of compulsory liquidation, the loaner will suffer no losses.

Of course, cryptocurrency does not have the daily falling max limit of the Chinese stock market, so to achieve the above objectives, we need to simulate historical data (such as Monte Carlo method) to calculate the security warning line and the liquidation line.

Of course, the above is also based on the relatively stable value of the selected cryptocurrency. The cryptocurrency with too much value fluctuation is not suitable as a collateral. Even the warning line and the liquidation line cannot solve the problem.