Integrating macroeconomic variables into behavioral models for interest rate risk measurement in the banking book

Recent Basel Committee on Banking Supervision standards on interest rate risk in the banking book require the consideration of macroeconomic variables for modeling client behaviors, while no macroeconomic risk scenarios are prescribed by regulators or are generally agreed in the industry. Since macroeconomic variables and interest rates are correlated, projecting macroeconomic variables for interest rate risk measurement poses the challenge of maintaining consistency with regulator-prescribed interest rate scenarios. This paper proposes an approach to integrate macroeconomic variables with interest rate scenarios. The conditional expectation of macroeconomic variables on interest rate variables is used to capture their interdependence. Based on the mathematical properties of conditional expectation, we derive its nonparametric estimator. The resulting projections of macroeconomic variables are fully ;consistent with the given interest rate scenarios and are convenient for implementation in practice. An empirical application to Canadian fixed-term deposits is conducted to illustrate the proposed approach.