In order to measure the interest rate risk of banking accounts such as deposits and loans, this paper extends the value at risk (hereafter, VaR) analysis framework, which is useful for the risk evaluation of trading accounts.
In order to apply the VaR concept derived from trading accounts to banking accounts, we should take into account the following issues: (1) the longer risk evaluation period because of the inflexibility of adjustability of banking account positions; (2) the evaluation of risk included in the administered rates (the long-term prime rate and the short-term prime rate); and (3) the prepayment risk (associated with housing loans, etc.). Therefore, in this paper we first construct a VaR model including a term-structure model to express the stochastic process of market rate, the administered rate model, and the prepayment function model. Then, we perform a simulation using an imaginary portfolio to analyze the factors determining interest rate risk.
In conclusion, it has been proved that the factor of administered rates increases interest rate risk both in single products and in a portfolio. Taking into account the behavior of customers who want better interest rate conditions, the factor of prepayment decreases the present value, which is itself the basis of calculating risk. Finally, we perform a sensitivity analysis of model parameters to show the magnitude of model risk.
Keywords: Value at risk; Monte Carlo simulation; Holding period; Term-structure model; Heath-Jarrow-Morton model; Administered rate; Prepayment
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.
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