A Multi-Factor Model for the Valuation and Risk Managment of Demand Deposits

National Bank of Belgium Working Paper No. 83

46 Pages Posted: 9 Oct 2010

See all articles by Hans Dewachter

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics; Erasmus Research Institute of Management (ERIM)

Marco Lyrio

Insper Institute of Education and Research

Stan Maes

European Commission - DG Internal market and financial services; European Commission - DG Competition; KU Leuven - Department of Economics

Date Written: May 12, 2006

Abstract

How should we value and manage deposit accounts where deposits have a zero contractual maturity, but which, in practice, remain stable through time and are remunerated below market rates? Does the economic value of the deposit account differ from the face value and can we reliably measure it? To what extent is the economic value sensitive to yield curve changes? In this paper, we try to answer the above questions. The valuation is performed on yield curve, deposit rate and deposit balance data between December 1994 and June 2005 for a sample of Belgian bank retail savings deposits accounts. We find that the deposits premium component of Belgian savings deposits is economically and statistically significant, though sensitive to assumptions about servicing costs and outstanding balances average decay rates. We also find that deposit liability values depreciate significantly when market rates increase, thereby offsetting some of the value losses on the asset side. The hedging characteristics of deposit accounts depend primarily on the nature of the underlying interest rate shock (yield curve level versus slope shock) and on the average decay rate. We assess the reliability of the reported point estimates and also report corresponding duration estimates that results from a dynamic replicating portfolio model approach more commonly used by large international banks.

Keywords: Demand Deposits, ALM, Risk Management, Arbitrage Free Pricing, Flexible-Affine Term

JEL Classification: G12, G21

Suggested Citation

Dewachter, Hans and Lyrio, Marco and Maes, Konstantijn, A Multi-Factor Model for the Valuation and Risk Managment of Demand Deposits (May 12, 2006). National Bank of Belgium Working Paper No. 83, Available at SSRN: https://ssrn.com/abstract=1689550 or http://dx.doi.org/10.2139/ssrn.1689550

Hans Dewachter (Contact Author)

Catholic University of Leuven (KUL) - Department of Economics ( email )

Center for Economic Studies
Naamsestraat 69
Leuven, B-3000
Belgium
+0032 16 326859 (Phone)
+0032 16 326796 (Fax)

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Marco Lyrio

Insper Institute of Education and Research ( email )

R Quata 300
Sao Paulo, 04542-030
Brazil

HOME PAGE: http://www.insper.edu.br/en/faculty-and-research/marco-lyrio

Konstantijn Maes

European Commission - DG Internal market and financial services ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

European Commission - DG Competition ( email )

Place Madou, Madouplein 1
Saint-Josse-ten-Noode/Sint-Joost-ten-Noode
Brussels, B-1049
Belgium

KU Leuven - Department of Economics ( email )

Naamsestraat 69
2nd Floor
B-3000 Leuven
Belgium

HOME PAGE: http://www.econ.kuleuven.ac.be/ew/academic/intecon

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