On the risk management of demand deposits: quadratic hedging of interest rate margins

Alexandre Adam, Hamza Cherrat (), Mohamed Houkari, Jean-Paul Laurent and Jean-Luc Prigent
Additional contact information
Alexandre Adam: BNP Paribas Personal Finance
Hamza Cherrat: CY Cergy Paris University
Mohamed Houkari: Lycée Henri-IV
Jean-Paul Laurent: Université Paris 1 Panthéon-Sorbonne, PRISM and Labex Refi

Annals of Operations Research, 2022, vol. 313, issue 2, No 30, 1319-1355

Abstract: Abstract This paper examines the problem of hedging banks interest rate margins. We assume that the demand’s deposits follow an exponential Lévy process with potential jumps. The forward market rates are assumed to follow the standard market model introduced by Brace et al. (Math Finance 7(2):127–155, 1997). As Adam et al. (Hedging interest rate margins on demand deposits, Université Paris 1 Panthéon-Sorbonne working paper, 2012), we consider that deposit rates depend linearly on market rates. Face to incompleteness, the liability manager must hedge both interest rate and demand deposit risks. For this purpose, we introduce various quadratic hedging criteria, allowing us to provide explicit hedging strategies that we further analyze. We illustrate in particular the impact of both the trends and the volatilities of interest rates and demand deposits.

Keywords: Risk management; Demand deposits; Interest rate margins; Quadratic hedging (search for similar items in EconPapers)
Date: 2022
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Working Paper: On the risk management of demand deposits: quadratic hedging of interest rate margins (2022)
Working Paper: On the risk management of demand deposits: quadratic hedging of interest rate margins (2020)
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DOI: 10.1007/s10479-020-03726-1

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