Long-Term Bank Balance Sheet Management: Estimation and Simulation of Risk-Factors
John R. Birge
University of Chicago - Booth School of Business
Montepio Bank; Instituto Superior de Ciencias do Trabalho e da Empresa (ISCTE)
June 21, 2012
We propose a dynamic framework which encompasses the main risks in balance sheets of banks in an integrated fashion. Our contributions are fourfold: 1) solving a simple one-period model that describes the optimal bank policy under credit risk; 2) estimating the long-term stochastic processes underlying the risk factors in the balance sheet, taking into account the credit and interest rate cycles; 3) simulating several scenarios for interest rates and charge-offs; and 4) describing the equations that govern the evolution of the balance sheet in the long run. The models that we use address momentum and the interaction between different rates. Our results enable simulation of bank balance sheets over time given a bank's lending strategy and provides a basis for an optimization model to determine bank asset-liability management strategy endogenously.
Number of Pages in PDF File: 18
Keywords: Balance sheet management, asset-liability management, long-term risk, interest rate risk, credit risk
JEL Classification: C58, G21working papers series
Date posted: June 22, 2012 ; Last revised: August 1, 2012
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