A Guide to Behavioural Modelling
First published:
ISBN: 978-1-78272-404-9
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A Simple Approach to Modelling Prepayment Events
Matteo Formenti and Mattia Rossi
Introduction
Insights on Banks’ Recourse to Behavioural Models from a Focused IRRBB Stress Test
Implementing Regulatory Guidance on IRRBB Behavioural Models: Challenges and Opportunities
The Stakeholders of Interest Rate Risk Behavioural Models
Governance of Behavioural Models
The Nature of IRRBB and Typical Metrics Employed
A Framework for Developing NMD Behavioural Models
The Literature on NMD Behavioural Models
Interest Rate Risk of Non-maturity Bank Accounts: From Marketing to Hedging Strategy
NMDs and IRRBB: A Methodological Proposal for a Behavioural Model
NMD Modelling: A Financial Wealth Allocation Approach
A Benchmark Framework for NMDs: An Application
NMD Behavioural Models Used in Marketing
The Validation of NMD Behavioural Models
The Choice of Maturity Profile in NMD Behavioural Models
Acknowledging the Elephant in the Room: The Mismatch Centre
Prepayment Risk Modelling for ALM, Finance and FTP: A Survival Model
Modelling of Prepayment on Fixed Rate Residential Mortgages: A Logistic Regression Approach
A Simple Approach to Modelling Prepayment Events
Integrating Credit Risk within the ALM Framework
Modelling Committed Credit Lines
Accounting of the Sight Deposit and Hedging
Prepayment was defined by Kolbe and Zagst (2007) as “a borrower’s decision to exercise an early repayment option in a financial contract”. From a banking point of view, it represents a risk of liquidity, interest rate and, to a limited extent, foreign exchange risk. In particular, prepayment phenomena expose the bank to liquidity risk since the change of maturity profile has a considerable impact on the representation of the available funding sources. For example, an underestimation of prepayment exposes the bank to the risk of overestimating its future liquidity requirements (over-funding), as well as to the risk of increased long-term liquidity costs.
PREPAYMENT EVENTS AND LIQUIDITY AND INTEREST RATE RISK
Prepayment affects interest rate risk since the change in the maturity profile modifies the cashflows exposed to a change in value when interest rates change. As a consequence, the economic value and net interest income (NII) sensitivity will differ when comparing the contractual versus the behavioural profile. As an example, the prepayment of fixed rate loans exposes banks to the risk of overhedging since the real cashflow in the maturity profile will be lower than the
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