Modelling Non-Maturing Deposits with Stochastic Interest Rates and Credit Spreads

Andreas Bohn

This chapter introduces an approach to hedging non-maturing deposits under stochastic deposit volumes, interest rates and credit spreads. The method described allows outflows to be captured from the unexpected weakening of the creditworthiness of a financial institution. Furthermore, it allows modelling of the negative convexity from margin compression risks, which are the risks of market rates falling close to or below a floor for interest rates paid to clients. The approach allows the management of the present value – also referred to as economic value – of client deposit portfolios.

Following this introduction, a brief overview of the scope of the deposits product is provided. Subsequently, a static approach to constructing replicating portfolios is given. We then describe the simultaneous modelling of deposit volumes, interest rates and credit spreads and illustrate simulation results. The specific topics of hedge ratios for the margin compression risk and applications to decay models follow. A summary concludes the chapter.

The approach described in this chapter is similar to the approach to hedging the present value of demand deposits presented by Jarrow and van Deventer

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