Abstract
Under the condition of continuous innovation of financial derivatives and marketization of interest rate, interest rates fluctuate more frequently and fiercely, and the measurement of interest rate risk also attracts more attention. Under the premise that the fluctuation of interest rate follows fuzzy stochastic process, based on the option characteristics of financial instruments with embedded option, this paper takes effective duration and effective convexity as tools to measure interest rate risk when embedded options exist, tries to choose CIR extended model as term structure model, and uses the Monte Carlo method for hybrid low deviation sequences (HPL-MC) to analyze the prepayment characteristics of MBS, a representative financial instrument with embedded options, when interest rates fluctuate; on this basis, the effectiveness of effective duration management of interest rate risk is demonstrated with asset liability management cases of commercial banks.
Highlights
With the further acceleration of the process of global economic integration, the global financial liberalization and facilitation reform with the financial innovation of developed countries and the financial deepening of developing countries as the main content is becoming more and more intense; a country’s financial market can no longer develop in isolation, and it is bound to be integrated into the entire international financial market
On December 13, 2001, China officially became a member of the World Trade Organization (WTO)
According to the Financial Services Authority (FSA) of the world trade organization, each member country must make a commitment to open up the financial market and gradually bring 95% of the global financial service trade into the process of liberalization
Summary
With the further acceleration of the process of global economic integration, the global financial liberalization and facilitation reform with the financial innovation of developed countries and the financial deepening of developing countries as the main content is becoming more and more intense; a country’s financial market can no longer develop in isolation, and it is bound to be integrated into the entire international financial market. Xia et al built the benchmark interest rate jump model of deposits and conducted the numerical pricing of embedded option deposit and loan based on the Monte Carlo simulation method and studied the impact of embedded options on interest rate risk of China’s commercial banks by using comparative analysis method [7]. E traditional Monte Carlo simulation method is usually used to calculate the price of embedded option and the effective duration of securities with embedded option; the random number sequence generated by traditional MC in the simulation space is unevenly distributed, which wastes a large number of observations and reduces the operation efficiency; this paper uses a more advanced simulation method, namely, HPL-MC, based on the optimized interest rate risk management tools, namely, effective duration and effective convexity, makes an empirical analysis on the change of characteristics of financial instruments caused by the existence of embedded options, and demonstrates how commercial banks can effectively measure and manage interest rate risk when implicit options exist. With the decline of interest rate, when the cost of refinancing is less than the interest expense of maintaining the original loan, prepayment means “redemption” behavior will occur; such “redemption” right is interest rate put option
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