Replication of Non-Maturing Products in a Low Interest Rate Environment

Florentina Paraschiv, Michael Schürle

The risk management of non-maturing products is an important challenge for most banks, particularly for those with significant retail business. This task is complicated by the inherent options of these products: clients may add or withdraw volumes any time, and the product rate can be adjusted by the bank as a matter of policy. Both properties make future cashflows uncertain. Usually, non-maturing products are replicated by a portfolio of fixed-maturity instruments. Popular approaches are based on static investment or funding rules where the portfolio weights are determined with the aim of minimising the volatility of the margin between the average portfolio rate (or opportunity rate) and the product rate. In the past it was common to determine these weights based on the analysis of historical data. Due to the unprecedentedly low level of interest rates in the aftermath of the financial and the European debt crisis, it is often advocated that the portfolio composition should be adapted to a scenario of future interest rates and product data.

We provide examples showing that static rules are inefficient in both cases. As an alternative, we propose a novel method that we call “dyna

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