Stress testing interest rate risk exposure

Azamat Abdymomunov and Jeffrey Gerlach

Journal of Banking & Finance, 2014, vol. 49, issue C, 287-301

Abstract: In the current low interest rate environment, the possibility of a sudden increase in rates is a potentially serious threat to financial stability. As a result, analyzing interest rate risk (IRR) is critical for financial institutions and supervisory agencies. We propose a new method for generating yield-curve scenarios for stress testing banks’ exposure to IRR based on the Nelson-Siegel (1987) yield-curve model. We show that our method produces yield-curve scenarios with a wider variety of slopes and shapes than scenarios generated by the historical and hypothetical methods typically used in the banking industry and proposed in the literature. We stress test the economic value of equity of a bank balance sheet based on Call Report data from a large U.S. bank. We show that our method provides more information about the bank’s exposure to IRR using fewer yield-curve scenarios than the alternative historical and hypothetical methods.

Keywords: Bank; Interest rate risk; Stress testing; Scenario generation; Nelson-Siegel model (search for similar items in EconPapers)
JEL-codes: E47 G21 G28 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:49:y:2014:i:c:p:287-301

DOI: 10.1016/j.jbankfin.2014.08.013

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