Is Portfolio Margin Dangerous? Required reading for brokerage firm employees.

I recently came across a highly insightful 2010 working paper out of the University of Sydney Business School entitled "Portfolio Margining: Strategy vs Risk" by E.G. Coffman, JR & D. Matsypura & V.G. Timkovsky.

The paper explores a number of different ideas including the riskiness of regular Reg-T margin versus Portfolio margin, the impact that the Portfolio Margin Pilot program may have had in terms of contributing to the stock market crash of October 2008, and the authors' belief that strategy-based margin has been unfairly discredited as a result of misinformation about the computational complexity of the strategy-based margining problem combined with the general bias towards heuristics by those (typically of the lawyer mindset) setting strategy-based margin rules.

Here is the abstract for the paper: 

This paper presents the results of a novel mathematical and experimental analysis of two approaches to margining customer accounts, strategy-based and risk-based. Building combinatorial models of hedging mechanisms of these approaches, we show that the strategy-based approach is, at this point, the most appropriate one for margining security portfolios in customer margin accounts, while the risk-based approach can work efficiently for margining only index portfolios in customer margin accounts and inventory portfolios of brokers. We also show that the application of the risk-based approach to security portfolios in customer margin accounts is very risky and can result in the pyramid of debt in the bullish market and the pyramid of loss in the bearish market. The results of this paper support the thesis that the use of the risk-based approach to margining customer accounts with positions in stocks and stock options since April 2007 influenced and triggered the U.S. stock market crash in October 2008. We also provide recommendations on ways to set appropriate margin requirements to help avoid such failures in the future.

The paper is quite advanced and may not be accessible to the average reader. However, for the technically inclined reader, the paper is definitely worth a read as it contains thought provoking examples of how Portfolio Margin can cause a pyramiding of debt under certain plausible market scenarios. 

So what does this all mean? Admittedly, not that much for the average investor. 
However, this paper and the concepts it contains should be read and mastered by anyone who works in margin and risk control at a brokerage firm. I applaud the authors for their work. 

For your conveniance, I've included a copy of the paper below.