Evolving economy bank asset‐liability and risk management under uncertainty with hierarchical objectives and nonlinear pricing

Abstract

AbstractQuantitative modelling of the asset‐liability management (ALM) problem faced by banking institutions is reexamined in this paper. The model presented here joins stochastic programming with non‐linear goal programming (SNGP). A bank optimization model with multiple objectives, multiple non‐linear economic relationships and a complex options hedge is proposed as an extension to the contemporary model structure now used by most financial institutions. The model structure is particularly well suited to solve the ALM decision problem in evolving economies where shareholder value maximization is often stated across a multiple goal hierarchy. The result of solving the SNGP provided significant evidence that the method is viable for efficient bank management under quasi‐planned economics. Stating the non‐linear demand and supply relationships within the two‐stage representation of the stochastic decision environment proved to be an effective method for resolving complex pricing policy issues. Finally, the SNGP model extends prior ALM models by simultaneously hedging interest rate risk under uncertainty through the incorporation of a complex chooser option. The complex chooser option, a hedge with a known pay‐off, was chosen to assist an inexperienced management team with an effective risk‐abatement tool. Copyright © 2003 John Wiley & Sons, Ltd.