Modeling non-maturing liabilities

Sammanfattning: Non‐maturing liabilities, such as savings accounts, lack both predetermined maturity and reset dates due to the fact that the depositor is free to withdraw funds at any time and that the depository institution is free to change the rate. These attributes complicate the risk management of such products and no standardized solution exists. The problem is important however since non‐maturing liabilities typically make up a considerable part of the funding of a bank. In this report different modeling approaches to the risk management are described and a method for managing the interest rate risk is implemented. It is a replicating portfolio approach used to approximate the non‐maturing liabilities with a portfolio of fixed income instruments. The search for a replicating portfolio is formulated as an optimization problem based on regression between the deposit rate and market ratesseparated by a fixed margin. In the report two different optimization criteria are compared for the replicating portfolio, minimizing the standard deviation of the margin versus maximizing the risk‐adjusted margin represented by the Sharpe ratio, of which the latter is found to yield superior results. The choice of historical sample interval over which the portfolio is optimized seems to have a rather big impact on the outcome but recalculating the portfolio weights at regular intervals is found to stabilize the results somewhat. All in all, despite the fact that this type of method cannot fully capture the most advanced dynamics of the non‐maturing liabilities, a replicating portfolio still appears to be a feasible approach for the interest risk management.