Scenario Based Principal Component Value-at-Risk: an Application to Italian Banks' Interest Rate Risk Exposure

The paper develops a Value-at-Risk methodology to assess Italian banksÂ’ interest rate risk exposure. By using 5 years of daily data, the exposure is evaluated through a Principal Component VaR based on Monte Carlo simulation according to two different approaches (parametric and non-parametric). The main contribution of the paper is a methodology for modelling interest rate changes when underlying risk factors are skewed and heavy-tailed. The methodology is then implemented on a one year holding period in order to compare the results from those resulting from the Basel II standardized approach. We find that the risk measure proposed by Basel II gives an adequate description of risk, provided that duration parameters are changed to reflect market conditions. Finally, the methodology is used to perform a stress testing analysis.Interest rate risk, VAR, PCA, Non-normality, Non parametric methods

Banks and savings institutions audit manual, Volume 3

https://egrove.olemiss.edu/aicpa_guides/2173/thumbnail.jp

An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1997

This paper uses currency option data from the BMF, the Commodities and Futures exchange in Sao Paulo, Brazil, to investigate market expectations on the Brazilian Real-U.S. dollar exchange rate from October 1994 through July 1997. Using options data, we derive implied probability density functions (PDF) for expected future exchange rates and thus measures of the credibility of the “crawling peg” and target zone (“maxiband”) regimes governing the exchange rate. Since we do not impose an exchange rate model, our analysis is based on either the risk-neutral PDF or arbitrage-based tests of target zones. The paper, one of the first to use options data from an emerging market, finds that target zone credibility was poor prior to February 1996, but improved afterwards. The market anticipated periodic band adjustments, but over time developed greater confidence in the Real. We also test whether devaluation intensities estimated from these option prices can be explained by standard macroeconomic factors

A quantitative mirror on the Euribor market using implied probability density functions

This paper presents a set of probability density functions for Euribor outturns in three months’ time, estimated from the prices of options on Euribor futures. It is the first official and freely available dataset to span the complete history of Euribor futures options, thus comprising over ten years of daily data, from 13 January 1999 onwards. Time series of the statistical moments of these option-implied probability density functions are documented until April 2010. Particular attention is given to how these probability density functions, and their associated summary statistics, reacted to the unfolding financial crisis between 2007 and 2009. In doing so, it shows how option-implied probability density functions could be used to contribute to monetary policy and financial stability analysis. JEL Classification: C13, C14, G12, G13financial, financial market, options, probability density functions

Three essays on the interest rate forward-futures differential 1. Empirical investigation of the size and the nature of the Eurodollar futures-foward differential 2. Decomposition of the interest rate forward-futures price differential 3. How much premium is there for interest rate futures?

This dissertation analyzes a series of issues that surround both the theoretical modeling and the empirical estimation of the forward-futures differential, commonly known as the convexity adjustment. Opposite to theoretical implication, I find that the magnitude of the forward-futures rate differential is much smaller than what was expected, and that its sign is negative on many occasions. Neither asynchronicity bias, nor the unconventional feature of the Eurodollar futures pricing can explain the observed phenomena. The term structure interpolation error and the two business day lag between the fixing (settlement) date and the transaction (value) date to which the implied forward rates and prices are applied cannot be attributed to the observed abnormality either. I further show that the difference between the implied forward price obtained from the spot rate term structure and the original Eurodollar futures price at any point of time before maturity is composed of two parts: the element due to marking-to-market and the element arisen from the unconventional settlement of the Eurocurrency futures. It is also demonstrated that the discrepancy between the forward price and the futures price arisen from the unconventional settlement of the Eurocurrency futures can be hedged using a specific basket of caplets. This paper also performs the analysis for the three most traded interest rate futures contracts in Europe: EURIBOR futures, short sterling futures and Euroswiss franc futures. I show that the futures premium is barely detectible for the contracts with maturities below one year. The futures premium for maturities above twelve months varies across the models and is a subject to model assumptions regarding the volatility input and its evolution. Finally, I show that in the presence of the limits to arbitrage the rate on a forward rate agreement (FRA) contract and the respective implied forward rate derived from the spot yield curve would differ and their difference increases with the maturity. This finding allows to challenge the results in recently published works that argue that the convexity adjustment is not priced in by the FRA market makers

Essays on incomplete market and aggregate fluctuation

This thesis consists of three chapters on incomplete markets and aggregate fluctuations. Chapter 1 examines the impact of frictional financial intermediation in a heterogeneous agents new Keynesian (HANK) model. An incentive problem restricts banking sector leverage and gives rise to an equilibrium spread between the returns on savings and debt. The interest rate spread that impacts on the wealth distribution and movements in it subjects borrowers and savers to different intertemporal prices. The model generates a financial accelerator that is larger than in a representative agent setting, derives mainly from consumption rather than investment, and works through a countercyclical interest rate spread. Credit policy can mute this mechanism while stricter regulation of banking sector leverage inhibits households' ability to smooth consumption in response to idiosyncratic risk. Thus, although leverage restrictions stabilize at the aggregate level, we find substantial welfare costs. In Chapter 2, we show that it is optimal to pay more attention to employment stabilization when both a heterogeneity of households and the matching friction exist even though the price adjustment cost is substantial. This implies that the optimal policy needs to strike a balance between price adjustment and employment stability rather than to pursue complete price stabilization in order to make the poor better off. In addition, we study the effect of a time-varying transfer rule on the volatility of inflation and employment with respect to a volatile job separation shock. We find that the Ramsey planner pays less attention to employment stabilization when a countercyclical transfer rule is in operation. Chapter 3 analyzes the transmission mechanism of monetary policy to consumption in New Keynesian models with heterogeneous households. We show that in these models the countercyclical nature of profits, empirically false, plays a large role in amplifying the intertemporal substitution channel. On the other hand, the interest rate exposure channel, empirically large, plays a small role. We suggest expanding the role of the interest rate exposure channel, while dampening the amplification effect of countercyclical profits, is of primary quantitative importance in future work

Interest rate risk management : a case study of GBS Mutual Bank

Banks play a pivotal role in the economic growth and development of countries, primarily through the diversification of risk for both themselves and other economic agents. Interest rate risk is regarded as one of the most prominent financial risks faced by a bank. A large portion of private banks’ revenue stems from net interest income that is generated from the difference between various assets and liabilities that are held on the balance sheet. Fluctuations in the interest rate can alter a bank’s interest income and value, making interest rate risk management vital to its success. The asset and liability committee of a bank is the internal committee charged with the duty of managing the bank’s interest rate risk exposure through the use of various hedging strategies and instruments. This thesis uses a case study methodology to analyse GBS Mutual Bank interest rate risk management. Its specific business circumstances, balance sheet structure and the market conditions over a specified period are used to comment on the practicality of a variety of balance sheet positioning strategies and derivative hedging instruments. The thesis also provides recommendations for the bank’s asset and liability committee in terms of its functions and organisation. It is elucidated that the most practical balance sheet hedging strategies are a volume strategy and immunisation, while the most practical derivative hedging instruments are interest rate futures and interest rate collars. It is found that the bank has a well functioning asset and liability committee whose only encumbrance to its functionality is the inadequacy of the informational technology used to measure, control and manage its interest rate risk position. This thesis concludes by summarising the practicality of the various interest rate risk hedging alternatives available to the GBS Mutual Bank. Implementing a particular strategy or instrument depends, of course, on its asset and liability committee’s decision

OFHEO\u27s 2007 Fannie Mae Report of Annual Examination

Contains Examination Authority and Scope, Examination Conclusions, Matters Requiring Board Attention, Board and Management Supervision, Asset Quality and Credit Risk Management, Operations, Sensitivity to Interest Rate Risk, Liquidity, Earnings, and Capital