Securitized banking and interest rate sensitivity

Review of Quantitative Finance and Accounting - Gorton and Metrick (J Financ Econ 104:425–451, 2012) coin the term “securitized banking” to refer to the combination of asset...     

Banks' option to lend,interest rate sensitivity,and credit availability

Interest rate risk is a major concern for banks because of the nominal nature of their assets and the asset-liability maturity mismatch. This paper proposes a new way to derive a bank's interest rate sensitivity, by examining separately the effects of interest rate changes on existing loans(loans-in-place) and potential loans (loans-in-process). A potential loan is shown to be equivalent to an American option to lend, and is valued using option theory. An increase in interest rates generally has a negative effect on existing loans. However, if both deposit and lending rates rise by the same amount, the value of a potential loan generally increases. Hence a bank's lending slack (or ratio of loans-in-process to loans-in-place) will determine its overall interest rate risk. Empirical evidence indicates that low-slack banks indeed have significantly more interest rate risk than high-slack banks. The model also makes predictions regarding the effect of deposit and lending rate parameters on bank credit availability. Empirical tests with quarterly data are generally supportive of these predictions. This revised version was published online in June 2006 with corrections to the Cover Date.     

Determinants of interest rate swap spreads

This study argues that an interest rate swap, as a non-redundant security, creates surplus which will be shared by swap counterparties to compensate their risks in swaps. This action in turns affects swap spreads. Analyzing the time series impacts of the changes of risks of swap counterparties on swap spreads, we conclude that both lower and higher rating bond spreads have positive impacts on swap spreads. We also derive a risk–spread relation to test if swap counterparties are firms with differential credit ratings. Since the risk allocation between swap counterparties varies over business cycles, hence this factor needs to be controlled. We conclude that (1) similar results hold if the business cycle factor is controlled and (2) swap spreads contain procyclical element and are less cyclical than lower credit rating bond spreads.     

Exchange rate dynamics under alternative optimal interest rate rules

We explore the role of interest rate policy in the exchange rate determination process. Specifically, we derive exchange rate equations from interest rate rules that are theoretically optimal under a few alternative settings. The exchange rate equation depends on its underlying interest rule and its performance could vary across evaluation criteria and sample periods. The exchange rate equation implied by the interest rate rule that allows for interest rate and inflation inertia under commitment offers some encouraging results — exchange rate changes “calibrated” from the equation have a positive and significant correlation with actual data, and offer good direction of change prediction. Our exercise also demonstrates the role of the foreign exchange risk premium in determining exchange rates and the difficulty of explaining exchange rate variability using only policy based fundamentals.     

Exchange rate dynamics under alternative optimal interest rate rules

We explore the role of interest rate policy in the exchange rate determination process. Specifically, we derive exchange rate equations from interest rate rules that are theoretically optimal under a few alternative settings. The exchange rate equation depends on its underlying interest rule and its performance could vary across evaluation criteria and sample periods. The exchange rate equation implied by the interest rate rule that allows for interest rate and inflation inertia under commitment offers some encouraging results — exchange rate changes “calibrated” from the equation have a positive and significant correlation with actual data, and offer good direction of change prediction. Our exercise also demonstrates the role of the foreign exchange risk premium in determining exchange rates and the difficulty of explaining exchange rate variability using only policy based fundamentals.     

中国利率衍生品市场前瞻

近年来,全球金融衍生市场发展很快,衍生产品交易量已经远远超过基础证券市场.因其在对冲风险、发现价格、降低融资成本、提高市场效率和增强流动性等方面所发挥的重要作用,正在受到越来越多的关注.中国的金融衍生品市场还刚刚起步,目前推出的品种中,利率衍生品包括债券远期和利率掉期,汇率衍生品有外汇远期和货币掉期.国内衍生品运行一年多来,各品种的成交量逐步增加,市场成员的关注程度日益增强,其作用也在迅速扩大.     

Regime shifts in interest rate volatility

I find evidence of regime shifts in interest rate volatility using short-rate data from the U.S., the U.K., Japan, and Canada. The regime shifts, if unaccounted for, could lead to spurious volatility persistence when the volatility processes are estimated with the stochastic volatility (SVOL) model. In contrast, the apparent persistence in volatility drops sharply in three out of the four countries when I estimate the volatility processes with the regime-switching stochastic volatility (RSSV) model. I also contribute to the literature by showing how to account for correlation in the regime-switching stochastic volatility model, which is important for modeling asymmetric volatility.     

法国利率市场化进程评述

法国的利率市场化改革采取了渐进方式,大致经历了逐步放松存款利率管制和适应全球金融自由化的趋势逐步放开贷款利率限制两个阶段。存款保险制度的建立有效地防范了改革过程中面临的风险。利率市场化改革完成后,金融机构定价灵活性增强;债券市场和股票市场等融资渠道发展迅速;形成了由招标贷款利率以及回购贷款和票据贴现利率构成的市场基准利率上下限,构建了完善的利率调控体系。     

The learning cost of interest rate reversals

Many central banks in many time periods have sought to avoid interest rate reversals, but at present there is no good explanation of this phenomenon. Our analysis identifies a new learning cost associated with reversing the interest rate. In a standard monetary model with forward-looking expectations, data uncertainty and parameter uncertainty, a policy that frequently reverses the interest rate makes learning the key parameters of the model more difficult. Optimal monetary policy internalises this learning cost and therefore has a lower number of interest rate reversals.     

深入推进利率市场化改革

国务院发展研究中心金融研究所副所长巴曙松建议,继续加大利率市场化定价的债券市场等直接融资的规模,平稳减少管制的存贷款利率在整个金融市场上的比例,为未来平稳推进利率并轨提供平稳的市场环境;其次,选择部分市场化程度较高、自我约束能力较强、适应利率市场化冲击能力较高的商业银行,进行利率市场化的试点;在货币政策操作中更多运用利率等价格工具,重点完善市场化的利率体系,特别是要重点完善基准利率体系。建立利率市场化机制平稳运行所需要的各种金融基础设施,特别是市场退出机制、存款保险机制等。     

Departures from interest rate parity further evidence

Daily data are used to test the theory of interest parity between the Irish pound and three major currencies. The tests are carried out within the context of a model suggested by Pippenger (1978) and the statistical methodology used is spectral analysis. The Pippenger model emphasises the relaxation of two important implicit assumptions, the exogeneity of the interest differential and the assumed infinitely elastic supply of arbitrage funds, which have tended to characterise previous studies. We attempt to reconcile our results, which are generally supportive of interest parity, with the exchange control arrangements currently in force in Ireland.     

The real interest rate and aggregate supply

This paper analyzes the effects of the anticipated real interest rate on aggregate supply variables, in a model where time-to-produce and variable capital utilization play a crucial role. The potential importance of the present mechanism for business cycle theory lies in its ability to generate positive co-movements of employment, capital utilization, labor productivity, output and investment. These variables are predicted to be affected negatively by the real interest rate. Reduced forms for output and employment are derived and tested with Canadian data, taking estimates of the real interest rate prevailing in the United States as the relevant exogenous price.     

Bundesbank intervention effects through interest rate policy

This paper investigates the effects of the changes in the Bundesbank's discount and Lombard interest rates on the volatility of European Union country exchange rates relative to the German mark during 1987–93. The first year of the sample period contains the last major realignment in the ERM before its ‘breakdown’ in 1993. Using a parsimonious EGARCH model, we find that the conditional volatility of these exchange rates increased in response to interest rate changes, regardless of the rate change direction. This finding is in direct conflict with Bundesbank's public statements that indicate that its interest rate policy was designed to calm its foreign exchange markets.     

Covered interest rate parity in emerging markets

This paper finds that while covered interest rate parity holds for large and small triple A rated economies, it holds for emerging markets only for a three-month maturity. For a five-year horizon the size and frequency of violations lead to the conclusion that covered interest rate parity does not hold for longer maturities for Brazil, Chile, Russia and South Korea. Overall this paper finds that aspects of credit risk are the source of violations in CIRP in the long-term capital markets rather than transactions costs or the size of the economy.     

A chaotic approach to interest rate modelling

This paper presents a new approach to interest rate dynamics. We consider the general family of arbitrage-free positive interest rate models, valid on all time horizons, in the case of a discount bond system driven by a Brownian motion of one or more dimensions. We show that the space of such models admits a canonical mapping to the space of square-integrable Wiener functionals. This is achieved by means of a conditional variance representation for the state price density. The Wiener chaos expansion technique is then used to formulate a systematic analysis of the structure and classification of interest rate models. We show that the specification of a first-chaos model is equivalent to the specification of an admissible initial yield curve. A comprehensive development of the second-chaos interest rate theory is presented in the case of a single Brownian factor, and we show that there is a natural methodology for calibrating the model to at-the-money-forward caplet prices. The factorisable second-chaos models are particularly tractable, and lead to closed-form expressions for options on bonds and for swaptions. In conclusion we outline a general international model for interest rates and foreign exchange, for which each currency admits an associated family of discount bonds, and show that the entire system can be generated by a vector of Wiener functionals.Received: March 2004, Mathematics Subject Classification (2000): 91B28, 91B30, 91B50, 60H07JEL Classification: E43We are grateful to J. Boland, D. Brody, P. Carr, M. Davis, F. Delbaen, D. Filipovi, R. Jarrow, M. Grasselli, P. Hunt, T. Hurd, D. Madan, P. Malliavin, H. Rasmussen and M. Zervos for stimulating discussions. We thank D. Brody, M. Grasselli, T. Hurd and M. Zervos, in particular, for suggesting a number of improvements in the arguments presented here. We are grateful for helpful comments by participants at the Frontiéres en Finance seminar, Paris, May 2002, the Mathematics in Finance conference, Kruger Park, RSA, August 2002, the Imperial College finance seminar, February 2003, the 13th annual Derivative Securities Conference, New York, April 2003, the Analysis of Random Markets Workshop, Banach Center, Warsaw, October 2003 and the Quantitative Methods in Finance Conference, Sydney, December 2003, where this work was presented. LPH acknowledges the hospitality of the Institute for Advanced Study, Princeton, where part of this work was carried out. AR acknowledges financial support from the Department of Mathematics, Kings College London.