dymamic modeling nonmaturing account

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Unformatted text preview: www.finance.unisg.ch December 2006 Dynamic modelling and optimization of non-maturing accounts Karl Frauendorfer Michael Schürle Working Papers Series in Finance Paper No. 43 Dynamic modelling and optimization of non-maturing accounts Karl Frauendorfer Michael Sch¨urle Institute for Operations Research and Computational Finance University of St. Gallen, Switzerland Abstract The risk management of non-maturing account positions in a bank’s balance like savings deposits or certain types of loans is complicated by the embedded options that clients may exercise. In addition to the usual interest rate risk, there is also uncertainty in the timing and amount of future cash flows. Since the corresponding volume risk cannot directly be hedged, the account must be replicated by a portfolio of instruments with explicit maturities. This paper introduces a multistage stochastic pro- gramming model that determines an optimal replicating portfolio from scenarios for future outcomes of the relevant risk factors: Market rates, client rates and volume of the non-maturing account. The weights for the allocation of new tranches are frequently adjusted to latest observa- tions of the latter. A case study based on data of a real deposit position demonstrates that the resulting dynamic portfolio provides a significantly higher margin at lower risk compared to a static benchmark. 1 Introduction A significant portion of a typical bank’s balance are so-called non-maturing accounts (NMAs). Their characteristic feature is that they have no specific contractual maturity, and individual clients can always add or withdraw invest- ments or credits at no (or a negligible) penalty. On the other hand, the bank is allowed to adjust the customer rate any time as a matter of policy. Typical examples of NMAs include savings and sight deposits on the liability side of the balance as well as credit card loans or variable-rate mortgages as they are common in some European countries on the asset side. Although the client rate is mostly adjusted in sympathy with the direction of changes in money and capital market yields, it does not completely depend on the latter. In practice, an adaption (often in discrete increments) follows only after larger variations in open-market rates and with some delay due to administrative and other costs involved. There might also be a (political) cap like in case of variable-rate mortgages in Switzerland where housing rents are indexed to an “official” mortgages rate. 1 2.5 3.0 3.5 4.0 4.5 5.0 5.5 88 90 92 94 96 savings deposits 10 15 20 25 30 35 40 4.5 5.0 5.5 6.0 6.5 7.0 7.5 88 90 92 94 96 variable mortgages 20 25 30 35 40 45 50 client rate (%, left) volume (bio. CHF, right) Figure 1: Correlation between client rate and volume during the early 1990s 1.1 Specific problems of non-maturing accounts One can often observe that the volume of a NMA position fluctuates heavily as clients react to changes in the customer rate and the relative attractiveness of...
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This note was uploaded on 11/10/2011 for the course ECON 101 taught by Professor Schurle during the Spring '11 term at University of Missouri-Kansas City .

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dymamic modeling nonmaturing account - www.finance.unisg.ch...

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