University of Twente Student Theses


Quantitative Effects of Switching Risk Measures on Portfolios of Interest Rate Instruments

Savelkoel, J. (2022) Quantitative Effects of Switching Risk Measures on Portfolios of Interest Rate Instruments.

[img] PDF
Abstract:The capital requirements for banks are determined by the risk measures used to estimate the exposure to all types of risks. In the latest version of the Basel accords, expected shortfall is introduced as the replacement of value at risk, which should result in a more complete estimation of market risk. Although there has been some research on the actual impact on the regulatory capital, there is little literature on its effect on interest rate securities and derivatives. The goal of the present work therefore is to provide insights in the quantitive effect of switching to expected shortfall as the market risk measure on portfolios of interest rate instruments. Furthermore, we investigate how portfolio composition affects the expected shortfall relative to the value at risk, and how expected shortfall and its underlying statistical properties behave under different interest rate environments. We use the Hull-White model to simulate daily six-month Euribor term structures over a fouryear time span. The model’s parameters are calibrated on co-terminal swaptions, whereafter we perform Monte Carlo simulations to obtain a distribution of hypothetical yield curve paths for each of the business days within the considered time span. A selection of interest rate instruments ranging in linearity is priced and combined into different portfolios. From the profit and loss distribution resulting from the Monte Carlo paths, we calculate the one-day risk measures. These are compared and analysed for and between the portfolios. Moreover, we subject them to statistical tests to determine if there is a significant difference. The overall trend we observe is that the 97.5% expected shortfall is slightly higher than the 99% value at risk. However, strategic hedging does not only impact their absolute values, but can also lower the expected shortfall relative to the value at risk. Furthermore, during periods of extreme market stress, we observe an increase in volatility and thus in expected shortfall. The through-time statistical tests indicate that the two risk measures significantly differ from each other. The experiments and analysis performed in the present work provide for a better understanding of the behaviour of the expected shortfall. The observations on the quantitative impact for portfolios of interest rate instruments can help financial institutions in the transition between market risk measures. The applied techniques can be tailored to the composition of a specific portfolio to obtain an accurate estimate of the risk exposure, while the observed trends give direction to strategic mitigation of the regulatory capital required through modification of the portfolio.
Item Type:Essay (Master)
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Industrial Engineering and Management MSc (60029)
Link to this item:
Export this item as:BibTeX
HTML Citation
Reference Manager


Repository Staff Only: item control page