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Interest rate risk in the banking book goes ballet : balancing between earnings and economic value volatilities

Seidel, Laura (2018) Interest rate risk in the banking book goes ballet : balancing between earnings and economic value volatilities.

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Abstract:The phrase ’interest rate risk in the banking book’ implies that the banking book is sensitive to fluctuations in market interest rates. Interest rate risk in the banking book (IRRBB) and its complexity has remained unexplored as the spotlight on the banking industry has been mostly on liquidity, capital conduct and regulatory scrutiny. However, this situation is changing. Currently, regulators are considering standardizing the management of IRRBB to a certain extent. IRRBB can be evaluated from both earnings and economic value perspectives. These two perspectives are the focus of this research. In this research the earnings perspective is measured in terms of NII and the economic value perspective is measured in terms of EVE. These two perspectives have different assumptions, employ different methodologies and results in different outcomes. Thus, these two perspectives result in a trade-off. This research investigates this tradeoff with risk management hedging techniques. The banking book of a retail bank is usually hedged from the earnings perspective which results in stable and predictable earnings and low earnings volatility. However, hedging from the earnings perspective results in a margin that is not being hedged and economic value volatility. By means of conducting a case study and implementing BPV and notional hedging techniques it is shown that the economic value volatility arises when there is no earnings volatility and earnings volatility arises when there is no economic value volatility. The optimal balance in the trade-off between earnings and economic value volatilities depends on the bank’s risk appetite and balance sheet.
Item Type:Essay (Master)
Clients:
Zanders Treasury & Finance Solutions
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Industrial Engineering and Management MSc (60029)
Link to this item:http://purl.utwente.nl/essays/74690
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