Identifying, valuing and hedging of embedded options in non-maturity deposits

Andreas Blöchlinger

Journal of Banking & Finance, 2015, vol. 50, issue C, 34-51

Abstract: Non-maturity deposits like savings accounts or demand deposits contain significant option risks caused by the bank’s discretionary pricing and the customers’ withdrawal right. Option risks follow from inherent non-linear factor exposures. I propose an ordinal response model for deposit rate jumps to identify non-linear factor exposures and a discrete-time term structure model to value the resulting option risks and to derive hedge measures “outside the model”. My delta profile resembles a constant maturity swap, but vega and gamma are more pronounced, which demonstrates that the widespread practice of static hedging with zero bonds is inadequate.

Keywords: Discrete-time dynamic term structure model; Discretionary pricing; Mark-to-model valuation; Ordinal response model; Volatility risk (search for similar items in EconPapers)
JEL-codes: C25 E43 G21 G28 (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:50:y:2015:i:c:p:34-51

DOI: 10.1016/j.jbankfin.2014.09.013

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