Interest Rate Risk Management Research Articles

Практика использования ESG-подходов в сделках секьюритизации

The spread of the sustainable development concept has given rise to sustainable finance, as well as the infrastructure of the financial and consulting industry of valuations, verifications and various databases in the field of ESG. This research is devoted to theoretical and practical study of the accumulated experience of ESG securitization transactions in order to systematize ESG financing instruments and directions of development of this sphere in modern conditions. The study showes that ESG securitization practices are being integrated into capital management processes in line with sustainable development goals, with the most developed centers in the USA, Europe and China. The study systematizes the main types of ESG securitized assets, gives their characteristics and identifies current trends. In Russia, despite its isolation from the world financial markets, the practice of ESG securitization is developing, covering new directions. The study notes the potential for the development of green mortgages, which will contribute to the activation of securitization transactions in the segment of residential and commercial real estate. High potential for development of the social segment of ESG securitization is also noted due to the growing demand for financing social projects in the regions. Expansion of the practice of social mortgage securitization will contribute to the redistribution of risks between the public and private sectors, while active involvement of Russian banks in a variety of ESG lending programs (car loans, lending to small and medium-sized businesses with a green and social focus, e.g. for the construction of social infrastructure, etc.) will expand the market. There is a suggestion that the development of digital ESG securitization platforms will help expand the reach of retail investors, while cooling the junk bond market. The article notes that the expansion of multi-tranche ESG securitization will allow long-term assets of pension funds and various ESG funds to be leveraged into mortgage-backed securities. Overall, ESG securitization improves the structure of transactions, expands the range of derivatives used, improves the quality of credit and interest rate risk management, and contributes to the achievement of sustainable development goals.

Price discovery and volatility spillovers in the interest rate derivatives market

The interest rate derivatives market is an important force in promoting the development of the bond market and is an effective tool to manage interest rate risk. The research on price discovery and volatility spillover of the market can help provide valuable reference information for investors. Based on treasury bond futures and interest rate swaps, the paper aims to discuss the price discovery function and spillover structure of the interest rate derivatives market. The paper establishes the information share model and spillover index model for empirical analysis. The results show that: First, the calculation results of the information share model show that the price discovery of treasury bond futures and interest rate swap markets is stronger than that of the spot market. Second, based on structural break analysis, treasury bond futures and interest rate swaps do not have breakpoints, while the treasury bond spot has three breakpoints. The paper divides the entire sample into four stages based on structural breakpoints and finds that the price discovery ability of the interest rate derivative market dynamically changed. Third, as a net spillover in the market, treasury bond futures have developed relatively stable. Both treasury bond futures and interest rate swaps have spillover effects on the spot market, indicating that China’s interest rate derivatives market can impact the treasury bond spot market.

What’s Wrong with Annuity Markets?

Abstract We show that the supply of U.S. life annuities is constrained by interest rate risk. We identify this effect using annuity prices offered by life insurers from 1989 to 2019 and exogenous variations in contract-level regulatory capital requirements. The cost of interest rate risk management—conditional on the effect of adverse selection—accounts for about half of annuity markups, or 8 percentage points. The contribution of interest rate risk to annuity markups sharply increased after the Global Financial Crisis, suggesting new retirees’ opportunities to transfer their longevity risk are unlikely to improve in a persistently low interest rate environment.

Monetary momentum and risk management in stock market

Purpose- This study aims to investigate the relationship between monetary interest rate decisions, liquidity mechanisms and risk management issues. As a core interest the significance of a structural change in the data around the FOMC meetings is analyzed. By the help of continuous time models we analyze the kind of dynamics, which can be observed in the stock returns, i.e. conditional volatilities and jumps. A further central interest is given to investment decisions and risk management issues. This encompasses the elaboration of the hedging strategies to achieve higher performance. Methodology- The study employs GARCH-Ito and GARCH-Ito-Jump models to analyze the stock market returns and their related volatilities on the day of a FED interest decision announcement. The continuous time GARCH model setting allows to model stock market returns with a high flexibility, therefore these models are abled to capture jump dynamics in the stock returns. Findings- The analysis reveals that persistence in conditional volatilities change according to alternative stocks. These stocks can be classified according to alternative market capitalization sizes. Mega market capitalization stocks are better governed by no jump GARCH-Ito models regardless the monetary policy changes, that is, changes in interest rates or not. Conclusion- Based upon the analysis, it may be concluded that risk management applications effectively might perform under the consideration of stock types in terms of market sizes. The persistence in the conditional volatility massively decreases if a jump component is introduced into the model. Since most of the mega market cap stocks perform better without a jump part component, it might be conjectured that persistence in the conditional volatility for mega cap stocks play a more important role compared to large cap stocks. Regardless the case whether there is an interest rate change or not, the persistence in conditional volatility remains in mega cap stocks, and thus, these stocks are prone to the involvement of prices jumps. Keywords: Monetary policy, risk management, jump detection, investment decisions JEL Codes: C22, E49, G11

Measuring Interest Rate Risk Management by Financial Institutions

Financial intermediaries manage myriad interest rate risk exposures. We propose a new method to measure financial intermediaries' residual interest rate risk using high-frequency financial market data. Our method exploits all available high-frequency information and is valid under extremely weak assumptions. Applying the method to U.S. life insurers, we find their interest rate risk management strategies are generally effective. However, life insurers are more sensitive to changes in long-term interest rates than property and casualty insurers. We show that the term premium helps to explain the difference in sensitivities between the two types of insurer.

Derivatives in Banking: A Platform for Teaching

Risk management is the core business of a bank. The transformation of a riskless (to the customer) deposit account into a risky (to the bank) asset is how a bank adds value and earns a profit. Successfully managing this is risk is therefore vital to the success of a bank. Banks are subject to many forms of risk, including interest rate risk, credit risk, liquidity risk, funding risk, and others. While banks cannot eliminate risk, they can control certain areas of their exposure. This project describes an exercise that demonstrates a method of managing interest rate risk in an uncertain environment and the risk-reward tradeoff of using financial derivatives to reduce risk. The exercise is beneficial to students in the banking field as well as those interested in investments as it provides a method to actually see the advantages and disadvantages of the hedging process. This guided experiential learning process should better prepare both groups of students as they begin their chosen careers.

Analysis of the Impact of Interest Rate Derivatives on the Market Risk of Commercial Banks in China

With the development of China's financial derivatives market, China needs to pay more attention to the management of interest rate risk, and commercial banks should avoid interest rate risk typically through the role of derivatives. China's financial markets have been opened up to the rest of the world, and many international factors are influencing the changes in our financial markets. This paper focuses on the function of interest rate derivatives and their impact on commercial banks in China. This is an important step for commercial banks in China to take in order to reform and improve themselves. Using interest rate derivatives to enable banks to reduce their operational risks and to ensure the safety of China's financial system is the goal of this paper. According to the findings of the research, the adoption of interest rate derivatives can help commercial banks decrease their exposure to market risk, credit risk, and liquidity risk.

Practical Applications of Maximizing Capital Efficiency in US Defined Benefit Pension Plan Immunizing Portfolio Construction Using Derivatives and a Power Law Relationship

In <b><i>Maximizing Capital Efficiency in US Defined Benefit Pension Plan Immunizing Portfolio Construction Using Derivatives and a Power Law Relationship</i></b>, from the April 2022 issue of <b><i>The Journal of Portfolio Management</i></b>, <b>Scott McDermott</b> of <b>Goldman Sachs Asset Management</b> explores the challenges of asset-liability risk management for the portfolios of defined-benefit pension plans. He first divides a plan’s portfolio into two components: one allocated to managing asset-liability matching (an “immunizing portfolio” or “IP”) and a second allocated to outperform the plan’s liabilities over time (a “growth portfolio” or “GP”). McDermott argues that an IP should be managed dynamically, to maximize capital efficiency, and that, when capital is scarce, managing interest rate risk takes priority over managing credit risk. However, the proportion of capital used for managing credit risk should increase as a plan’s funding status improves. The author proposes a power law relationship between the hedge ratios for interest rate risk and credit risk. He recommends using interest rate and other derivatives to maximize the efficiency of the strategy. The author thinks all managers should ask the following question: Which is riskier, interest rate or credit spread risk? Which has the most volatility, Treasury yields or corporate spreads? Which should we focus on hedging first, and how should we make the trade-off? His research provides fund managers with an approach to answer these questions and develop a more efficient hedging program.

Measuring Interest Rate Risk Management by Financial Institutions

Measuring Interest Rate Risk Management by Financial Institutions

Data mining application with machine learning algorithms to manage interest rate risk

In trade, the risks taken may increase the expected income; however, they may also cause large amounts of losses as well. Banks transfer the capital and the deposits they collect from their clients to the individuals or institutions in need of profit, taking certain risks into account. One of the important risks taken in this process of capital transfer is the market's change in interest or profit share rates. If the bank transfers the deposit collected with a certain commitment to the market at a lower rate, it will make a loss. Models for predicting future interest or profit share rates gain importance for preventing this situation. The aim of this study is to determine which variables will be taken into account for the loan interest rate that banks will offer to their customers during the lending process, and to create a machine learning model that can predict the loan interest rate that the bank will offer to its customers by using these variables. Multiple Linear Regression analysis was performed to demonstrate the relationship between the variables selected based on the literature review, expert opinions, and the interest rate. In order to facilitate decision-makers in practice, Random Forests, Decision Trees, K-Nearest Neighbours (KNN), Artificial Neural Networks (ANN), and Support Vector Machine (SVM) algorithms from machine learning algorithms were compared by using the prediction model. Accuracy Rate, Cohen's Kappa, Precision, Sensitivity, and F-Measure measurements were used to compare the algorithms used in the study. According to the analysis results, it was observed that the Random Forest algorithm was more successful on the first model consisting of weekly data. The Decision Tree algorithm succeeded more on the second model consisting of monthly data prediction performance. In the model consisting of weekly data, USD Selling Price, Stock Index (BIST100), and Central Bank Gold Reserve from the Multiple Linear Regression variables were found significant in affecting the interest rate.

Impact of Risk Management on the Financial Performance of Listed Deposit Money Banks (DMBS) in Nigeria

This study looks at how risk management affects Nigeria's publicly listed deposit money institutions' financial performance (DMBs). The 10 commercial banks in Nigeria with licenses are being researched. The data used spans 12 years from 2009 to 2020 and is secondary data. The Hausman test was chosen because it suggests that a random effect model should be employed for the analysis of the panel data utilized in this study. It was determined that there is a statistically significant association between net interest margin (NIM), credit risk management (CRM), liquidity risk management (LRM), and interest rate risk management (INTRM) using the ordinary least square random effect regression model. More specifically, credit and interest rate risk management have a significant negative impact on the profitability of Nigeria's listed deposit money banks, suggesting that an increase in risk management variables will result in a decline in the financial performance of Nigeria's listed deposit money banks. Therefore, to boost their profitability, Nigeria's listed deposit money banks must enhance their credit risk management techniques.

Topical issues of interest rate risk management (evidence from Chinese banks)

Статья посвящена вопросам управления процентным риском в коммерческих банках на современном этапе, в статье делается акцент на действующих управленческих подходах, целью которых является рост стоимости компании. По мнению авторов, доступный инструментарий управления процентным риском в РФ и КНР используется в начальном объеме. Характеристики этапа развития денежно-кредитной системы РФ и КНР во многом схожи. В статье приводятся данные по основным группам банков КНР о размере принимаемого процентного риска, дана оценка инструментов управления процентным риском, а также приводятся примеры и возможные варианты снижения процентного риска при использовании отдельных схем управления активами и пассивами. Авторы полагают, что проведенные исследования практики управления процентным риском в сопоставлении с имеющимся инструментарием на развитых финансовых рынках позволяют сформулировать следующее заключение: коммерческие банки зарабатывают на принятии процентного риска, но на формирующихся рынках используют инструменты управления процентным риском в начальном объеме.

Research on Interest Rate Risk Management Based on Duration, Convexity and Immunization

For bond investors and fundraisers, interest rate risk is an inescapable issue that requires attention. Therefore, efficiently measuring and preventing interest rate risk is a topic worthy of in-depth research. Duration, modified duration and convexity are tools that can be used to measure different interest rate risks. Based on the concepts of duration, immunization is introduced as an effective strategy to shield investors’ overall financial status. This paper mainly reviews the development and evolution of duration, modified duration, convexity and immunization strategy. In addition, the application scenarios of duration and convexity and improved immunization strategies are discussed and served as a reference for investors and financiers when hedging interest rate risks.

Banks’ Management of Interest Rate Risk: Empirical Evidence from Savings Banks and Credit Cooperatives

Abstract German banking supervisors repeatedly warn of the potential threats arising from the current levels of interest rate risk. Especially banks with a traditional business model that highly depend on income from their interest business have extended their maturity transformation to stabilize the net interest margins with higher term premiums. This paper uses a unique data set comprising balance sheet data from German savings banks and credit cooperatives enhanced with information from their disclosure reports between 2012 and 2020 to analyze the level of interest rate risk and its management. The results suggest that interest rate derivatives are not primarily related to the general level of interest rate risk in banks but may particularly be used by banks to avoid exceeding specific regulatory limits. Furthermore, smaller banks are less likely to use derivatives. However, the results suggest that these banks manage their interest rate risk exposure via higher shares of securities, giving these banks more flexibility in maturity management.

Maximizing Capital Efficiency in US Defined Benefit Pension Plan Immunizing Portfolio Construction Using Derivatives and a Power Law Relationship

The author puts forth a framework for how to invest efficiently against the two dominant risk factors facing US pension plans—interest rates and credit spreads—as a function of the capital allocated to the asset–liability risk management function (the immunizing portfolio [IP]). The framework uses derivatives and other instruments to vary the nature of the hedge investments as a function of IP capital and seeks efficient use of that capital. The result is a glide path for the IP capital allocation that emphasizes interest rate risk management when IP capital is scarce while balancing interest rate and credit risk management when IP capital is plentiful.

Measurement and Management of Interest Rate Risk of Commercial Banks: Based on VaR-GARCH Model of a Case Study of SHIBOR

With the acceleration of financial liberalization in China and the tremendous changes in the international financial situation, China’s commercial banks face considerable interest rate risks. The profitability and solvency of commercial banks have been impacted, leading to increased operational uncertainty and even systemic risks. The Shanghai Interbank Offered Rate, launched in 2007, tends to approach the benchmark interest rate in the financial market. Therefore, this paper selects The Shanghai Interbank Offered Rate (SHIBOR) overnight lending rate from January 2017 to July 2021 as a sample and adopts a method combining the VaR and GARCH models. Through empirical analysis, this paper establishes a GARCH model to eliminate the heteroscedasticity phenomenon in the data. The results show that the SHIBOR series has the characteristics of stationary, non-normal distribution, serial autocorrelation, and heteroscedasticity. The GARCH (2,2) model under the generalized error distribution (GED) is the most effective for measuring interest rate risk. Based on this, this article puts forward suggestions that commercial banks should enhance their awareness of interest rate risk management and should actively use financial derivatives to hedge interest rate risks.&#x0D;

Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement

Insurance companies and pension funds have liabilities far into the future and typically well beyond the longest maturity bonds trading in fixed-income markets. Such long-lived liabilities still need to be discounted, and yield curve extrapolations based on the information in observed yields can be used. We use dynamic Nelson-Siegel (DNS) yield curve models to extrapolate risk-free yield curves for Switzerland and several countries. We find slight biases in extrapolated long bond yields of just a few basis points. In addition, the DNS model allows the generation of useful financial risk metrics, such as ranges of possible yield outcomes over projection horizons commonly used for stress-testing purposes. Therefore, we recommend using DNS models as a simple tool for generating extrapolated yields for long-term interest rate risk management. This paper was accepted by Kay Giesecke, finance. Supplemental Material: The data files and online appendices are available at https://doi.org/10.1287/mnsc.2021.4215 .

Research on Interest Rate Risk of Housing Mortgage Loan Based on Computer Simulation.

In recent years, with the rapid increase of the business volume of housing mortgage loans of commercial banks, the risk of prepayment is increasingly exposed. Prepayment will have a great impact on the duration and convexity of housing mortgage loans of commercial banks and then bring difficulties to the asset liability management of banks. Therefore, empirical research on the changes of duration and convexity of housing mortgage loans caused by prepayment when the market interest rate changes is of great significance for commercial banks to manage interest rate risk exposure. Based on the analysis of the option characteristics of prepayable housing mortgage loan, the CIR model with GARCH(1, 1) is selected to describe the interest rate change path, and the computer simulation method is used to calculate OAS and then calculate the effective duration and effective convexity of housing mortgage loan under different prepayment rates, so as to understand the interest rate risk of housing mortgage loan in the presence of embedded option.

What's Wrong with Annuity Markets?

We show that the supply of life annuities in the U.S. is constrained by interest rate risk. We identify this effect using annuity prices offered by U.S. life insurers from 1989 to 2019 and exogenous variations in contract-level regulatory capital requirements. The cost of interest rate risk management accounts for at least half of the average life annuity markups or eight per- centage points. The contribution of interest rate risk to annuity markups sharply increased after the great financial crisis, suggesting new retirees' opportunities to transfer their longevity risk are unlikely to improve in a persistently low interest rate environment.

Pricing of Embedded Options in Bank Deposits and Loans Based on Jump-Diffusion Interest Rate Model

The marketization of interest rate is an inevitable requirement for China’s financial reform and joining the WTO to connect with the international financial market. It is also an important link to improve the marketization degree of China’s financial system. The marketization of interest rate in China is gradually advancing according to its preset mode. In the process of interest rate marketization, an unavoidable problem is that while the interest rate marketization gives the commercial banks the autonomy of capital pricing, the fluctuation of interest rate is more and more frequent. However, due to the fluctuation of interest rate, the loan as the main assets of commercial banks will be prepayed by borrowers, and the time deposit as the main liabilities of commercial banks will be withdrawn by depositors in advance; that is, embedded options are implied in asset liability items, which makes it difficult for commercial banks to accurately calculate the actual interest margin of deposits and loans and manage the interest rate risk. Therefore, it is of great significance to identify and price such embedded option value. On the basis of identifying and decomposing the embedded options in deposit and loan of commercial banks, according to the change characteristics of deposit and loan interest rate of Chinese commercial banks, this paper chooses jump-diffusion interest rate model to describe the change of benchmark interest rate of deposit and loan in China and demonstrates the advantages of this model compared with other models. Based on Monte Carlo simulation technology, the embedded options of five-year fixed deposit and ten-year prepayable loan in China are priced. On this basis, it points out that the real interest margin of commercial bank’s deposit and loan should be the nominal interest margin minus the value of deposit and loan’s embedded options. In the process of interest rate risk management, we should pay attention to the existence of embedded options and carry out effective management.