Handbook of Asset and Liability Management (eBook)

Applications and Case Studies

Stavros A. Zenios, William T. Ziemba (Herausgeber)

eBook Download: EPUB

2007 | 1. Auflage
684 Seiten
Elsevier Science (Verlag)
978-0-08-054856-2 (ISBN)

Infos

The Handbooks in Finance are intended to be a definitive source for comprehensive and accessible information in the field of finance. Each individual volume in the series presents an accurate self-contained survey of a sub-field of finance, suitable for use by finance and economics professors and lecturers, professional researchers, graduate students and as a teaching supplement.

It is fitting that the series Handbooks in Finance devotes a handbook to Asset and Liability Management. Volume 2 focuses on applications and case studies in asset and liability management.

The growth in knowledge about practical asset and liability modeling has followed the popularity of these models in diverse business settings. This volume portrays ALM in practice, in contrast to Volume 1, which addresses the theories and methodologies behind these models. In original articles practitioners and scholars describe and analyze models used in banking, insurance, money management, individual investor financial planning, pension funds, and social security. They put the traditional purpose of ALM, to control interest rate and liquidity risks, into rich and broad-minded frameworks. Readers interested in other business settings will find their discussions of financial institutions both instructive and revealing.

* Focuses on pragmatic applications
* Relevant to a variety of risk-management industries
* Analyzes models used in most financial sectors

Inhalt

Front cover 1
Applications and Case Studies 4
Copyright page 5
Introduction to the Series 6
Contents of the Handbook 8
Preface 12
Contents 16
Chapter 11. ALM in Banking 26
Abstract 27
Keywords 27
Introduction 28
1. Economics of banking, five main functions 29
2. The bank's balance sheet and income statement 32
3. Risk management in banking 35
4. Asset and liability modeling for banks 38
5. Application I. Pricing loan and loan loss provisioning 49
6. Application II. The measurement of interest rate and liquidity risks 53
7. Application III. Portfolio diversification, marginal risk contribution, and the allocation of economic capital 63
8. Bank regulations 67
9. Conclusion 70
Appendix A. The relevant maturity of the transfer price 71
Appendix B. Bank valuation, no tax-no growth 72
Appendix C. Bank valuation, the corporate tax case 73
Appendix D. Proof of marginal contribution formula 74
References 74
Chapter 12. Dynamic Financial Analysis for Multinational Insurance Companies 80
Abstract 81
Keywords 81
1. Introduction to dynamic financial analysis 82
2. Basic structure of a DFA system 85
3. Applications of DFA 101
4. Capital allocation and decentralized risk management 110
5. Conclusions and future work 119
Appendix A. Toolkit for constructing a DFA system 120
References 124
Chapter 13. Stochastic Programming Models for Strategic and Tactical Asset Allocation-a study from Norwegian life insurance 128
Abstract 129
1. Introduction 130
2. Motivation and model description 131
3. Data collection, market expectations and scenario generation 142
4. The impact of the TAA-model on the organization 147
5. Experiences 154
6. Conclusions 161
References 161
Chapter 14. Design and Management of Unit-linked Life Insurance Contracts with Guarantees 164
Abstract 165
Keywords 165
1. Introduction 166
2. Discrete-time modeling 171
3. Continuous-time modeling 182
4. Conclusion 196
References 197
Chapter 15. The Prometeia Model for Managing Insurance Policies with Guarantees 200
Abstract 201
Keywords 201
1. Introduction 202
2. The Italian insurance industry 205
3. The scenario optimization model 209
4. Model testing and validation 218
5. Conclusions 237
Acknowledgements 238
Appendix A. Solving the nonlinear dynamic equations 238
Appendix B. Asset classes 240
References 241
Chapter 16. Integrated Risk Control Using Stochastic Programming ALM Models for Money Management 244
Abstract 245
Keywords 245
1. Introduction 246
2. Multistage stochastic programming (MSP) 248
3. Investment optimization model 251
4. Portfolio risk metrics 259
5. Multistage portfolio rebalancing model 268
6. Model application 274
7. Concluding remarks 283
Acknowledgement 284
References 284
Chapter 17. Asset-Liability Management for Individual Investors 288
Abstract 289
Keywords 290
1. Introduction 291
2. Individual ALM in practice 293
3. ALM modeling for individual investors theory 305
4. The individual investor stochastic programming model 325
5. Problem generation and solution 341
6. Conclusions and directions 350
Acknowledgements 351
Appendix A. Indiv ALM mathematical outline 351
Appendix B. Operational Research Systems Personal Financial Planner™ 354
References 360
Chapter 18. A Scenario Approach of ALM 366
Abstract 367
Keywords 367
1. Introduction 368
2. Institutional setting and the definition of ALM 369
3. The ALM approach 372
4. ALM: Practical results 381
5. Conclusion 395
References 396
Chapter 19. The Russell-Yasuda Kasai, InnoALM and Related Models for pensions, insurance companies and high net worth individuals 398
Abstract 399
Keywords 399
1. Introduction 400
2. How to make good multiperiod models 401
3. Scenarios 404
4. Procedures for scenario generation 416
5. My philosophy 439
6. The Russell-Yasuda Kasai model 454
7. Pension models: Aging of the World's populations 468
8. Conclusions 491
References 493
Chapter 20. Dynamic Asset and Liability Management for Swiss Pension Funds 500
Abstract 503
Keywords 503
1. Introduction 504
2. Liability model for a Swiss pension fund 509
3. Basic principles of the pension fund model 511
4. The pension funds' current obligations 516
5. The pension funds' projected liabilities 518
6. Construction of the bucket structure 519
7. The information value of the bucket structure 528
8. Asset-liability management optimisation 530
9. Case study 548
10. Conclusion 561
References 562
Chapter 21. Joined-Up Pensions Policy in the UK: An Asset-Liability Model for Simultaneously Determining the Asset Allocation and Contribution Rate 566
Abstract 567
Keywords 567
1. Linkage between the asset allocation and the contribution rate 570
2. A multi-period portfolio model of the asset-liability problem 573
3. Transformation of the portfolio returns to contribution rates and funding ratios 576
4. Relaxing the assumptions of the Haberman (1992) model 579
5. The choice of the spread period 582
6. Regulatory and solvency risk 583
7. Description of the Universities Superannuation Scheme 585
8. Data 586
9. Solving the asset-liability portfolio model 587
10. Transformation of the portfolio returns to contribution rates and funding ratios 590
11. Choice of the spread period 593
12. Allowance for triennial valuations 595
13. Regulatory and solvency risk 596
14. Conclusions 598
Acknowledgements 599
Appendix A 599
References 600
Chapter 22. ALM Issues in Social Security 606
Abstract 607
Keywords 607
1. Background introduction to US Social Security 608
2. The crisis-is there one and what should be done about it? 616
3. Plans for saving social security 619
4. Rethinking and redesigning the social security system as part of a retirement package 639
5. Conclusions 651
References 652
Author Index 656
Subject Index 668

Textauszug

Handbook of Asset and Liability Management, Vol. 2, No. suppl (C) • 2007

ISSN: 1872-0978

doi: 10.1016/S1872-0978(06)02011-4

Chapter 11 ALM in Banking

Jean Dermine*E-mail address:[e-mail],

INSEAD, Fontainebleau, France

Abstract

The main purpose of the chapter is to discuss Asset & Liability Management, the control of value creation and risks in a bank. This chapter is innovative in two ways. First, unlike the usual practice of restricting ALM to the control of interest rate and liquidity risks, we propose a framework to analyze both value creation and the control of risks. Second, rather than discuss the ALM issues one by one in an independent manner, the chapter provides a microeconomic-based valuation model of a bank. This allows an integrated discussion of fund transfer pricing, deposit pricing (fixed and undefined maturities), loan pricing, the evaluation of credit risk provisions, the measurement of interest rate risk for fixed and undefined maturities, the diversification of risks, and the allocation of economic capital.

Besides a comprehensive summary of the literature on ALM in Banking, the chapter makes six contributions related to transfer pricing, risk-adjusted pricing of loans, provisioning of credit risk, the relevant maturity to price and hedge deposits with uncertain maturities, the after-tax valuation of equity, and the hedging of economic profit.

Keywords

• ALM • bank valuation • credit risk • interest rate risk • liquidity risk

JEL classification

• G21 • G28

Introduction

The main purpose of this chapter is to discuss Asset & Liability Management, the control of value creation and risks in a bank. The chapter aims to be comprehensive with a large coverage of the ALM literature, and to be innovative in two ways. First, unlike the usual practice of restricting ALM to the control of interest rate and liquidity risks arising from positions on balance sheet (the banking book),1 we propose a framework to analyze both value creation and the control of risks. Second, rather than discuss the ALM issues one by one in an independent manner, we provide a microeconomic-based valuation model of a bank. It allows us to discuss, in an integrated way, fund transfer pricing, deposit pricing (fixed and undefined maturities), loan pricing, the evaluation of credit risk provisions, the measurement of interest rate risk for fixed and undefined maturities, the diversification of risks, the marginal risk contribution, and the allocation of economic capital. The traditional purpose of ALM, the control of interest rate and liquidity risks, is thus integrated into a richer framework.

With reference to the organizational structure of banks, our integrative approach is closer to the organization of a J.P. Morgan Chase which operates with two major corporate risk committees: Capital and Risk Management. The Capital Committee reviews the adequacy of the firm’s capital and liquidity, and recommends the allocation of capital within the firm. The Risk Management Committee provides oversight and direction of risk profile and risk appetite, and reviews and approve corporate policies and risk strategies in a comprehensive way, not restricted to liquidity or interest rate risk on the banking book.

In Section 1, five specific but interrelated functions of banks are discussed in the light of modern banking theory. This permits us to identify the various services provided by banks. The balance sheet and income statement of a representative bank are presented in Section 2. As bank modeling is often concerned with the management of risks, fifteen sources of risk in banking are identified in Section 3, and the economics of risk management are discussed. Two microeconomic models of the banking firm are developed in Section 4. A neoclassical model facilitates discussion of the bank separation theorem and the pricing of deposits with fixed and undefined maturities. A bank valuation model enables us to break the value of the equity of a bank into four components: a liquidation value, a franchise value, a corporate tax penalty, and tax savings due to unrealized capital gains. Specific attention is given to relevant risk-adjusted discount rates to value bank assets and liabilities. Three applications of the model follows. In Section 5, the valuation model is applied to the pricing of risky loans and the fair evaluation of credit risk provisions. The discussion of the measurement of interest rate and liquidity risks in Section 6 will concern the risk on the banking book from both an ‘accounting earnings’ and an ‘economic value’ perspectives. Both finite maturity-products, such as term loans or term deposits, or products with undefined maturities, such as demand deposits or credit card loans, will be analyzed. We discuss, in Section 7, the aggregation of risks, the concept of marginal risk contribution, and the allocation of economic capital. Finally, in Section 8, we review briefly the rationale for bank regulation and the main types of regulations, as they relate to capital adequacy, interest rate risk, and liquidity risk.

Besides a comprehensive summary of the literature on ALM in Banking, this chapter makes six contributions related to transfer pricing, risk-adjusted pricing of loans, provisioning of credit risk, the relevant maturity to price and hedge deposits with uncertain maturities, the after-tax valuation of equity, and the hedging of economic profit.

1 Economics of banking, five main functions

A bank is a firm whose assets include primarily financial claims issued by borrowers, such as households, corporate firms, governments, and other financial intermediaries, and whose liabilities are sold as secondary claims to capital surplus units in various forms, such as demand deposits, savings deposits, term deposits, subordinated debt (loan capital), or equity shares. Keeping up with financial innovations, banks engage in various credit insurance-related activities, such as letters of credit, note-issuance facilities, or credit derivatives. Others types of contingent claims include financial derivatives, such as forwards, options or swaps, the payoffs of which are related to movements in interest rate, exchange rates, equity or commodity prices. With the exception of the transaction cost and the cash premium received or paid, these activities do not create an asset or a liability on the balance sheet. They belong to the off-balance sheet activities. Although the services provided by banks are interrelated, it is convenient to distinguish five categories of increasing complexity: underwriting and placement, portfolio management, payment (transmission) services, monitoring or information-related services, and risk sharing.

Underwriting and placement. A first service provided by financial intermediaries is to bring together savers and borrowers. Underwriting and placement of securities is a function which helps borrowers (corporate firms or public institutions) to meet surplus units, and structure or customize the type of securities that meet the risk/return requirements of borrowers and lenders. In this function, the underwriter is involved not only in designing the security, but also in the valuation of assets and the pricing of securities to ensure that the terms of the issue are competitive. Increasingly, rating agencies play a crucial role in providing independent evaluation of the risks incurred on these claims. As investors may wish in the future to transform these claims into cash, consumption or other securities, they need to be exchanged. Brokers/dealers or market makers provide these services to ensure secondary trading and liquidity. In a pure underwriting and placement service, it is assumed that the return and risk of the securities can be properly defined, so that there is no major problem of asymmetric information (agency problem) between lenders and borrowers. In this case, monitoring is not an issue. A pure case is the financing of public debt in countries where the sovereign risk is minimal. With the underwriting and placement service, the end-investor holds directly the claims on deficit units.

Portfolio management. At low cost, investors can acquire a diversified portfolio of securities issued by deficit spending units. The pure case is the mutual fund or unit trust (called SICAV in France and Luxembourg) which supplies a diversified portfolio to the holders of its shares. The income derived from the financial assets is paid to the holders of the shares less a fee paid to the fund manager.2 The reason for the existence of these funds is two-fold. The first is to reduce the divisional cost incurred in issuing many securities. The second is that investors may wish to delegate the assessment of economic prospects and fund management to specialists.

Payment mechanism. A third function performed by financial markets is the management of the payment system, i.e., to facilitate and keep track of transfers of wealth among individuals. This is the bookkeeping activity of banks realized by debiting and crediting accounts. Although the payment system is limited by regulation to a specific type of deposits (demand deposits), it could be achieved by debiting or crediting any type of liquid assets. The so-called cash management or sweep account which automatically transfers money from mutual funds into demand deposits is a perfect illustration of the...

Produkt-Details

• Erscheint lt. Verlag: 8.8.2007
• Sprache: englisch
• Themenwelt: Sachbuch/Ratgeber
• Themenwelt: Recht / Steuern ► Wirtschaftsrecht
• Themenwelt: Wirtschaft ► Betriebswirtschaft / Management ► Finanzierung
• Themenwelt: Wirtschaft ► Betriebswirtschaft / Management ► Rechnungswesen / Bilanzen
• Themenwelt: Betriebswirtschaft / Management ► Spezielle Betriebswirtschaftslehre ► Bankbetriebslehre
• Themenwelt: Wirtschaft ► Volkswirtschaftslehre
• ISBN-10: 0-08-054856-3 / 0080548563
• ISBN-13: 978-0-08-054856-2 / 9780080548562