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A multi-factor model for the valuation and risk managment of demand deposits

Author

Listed:
  • Hans Dewachter

    (Catholic University of Leuven, Center for Economic Studies
    Erasmus University Rotterdam, Rotterdam School of Management)

  • Marco Lyrio

    (University of Warwick, Warwick Business School, Finance Group)

  • Konstantijn Maes

    (National Bank of Belgium, Financial Stability Department)

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.

Suggested Citation

  • Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2006. "A multi-factor model for the valuation and risk managment of demand deposits," Working Paper Research 83, National Bank of Belgium.
    • Handle: RePEc:nbb:reswpp:200605-2
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    References listed on IDEAS

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    Cited by:

    1. Freriks, Jorien & Kakes, Jan, 2024. "Lessons from low interest rate policy: How did euro area banks respond?," Journal of International Money and Finance, Elsevier, vol. 146(C).
    2. Vajanne, Laura, 2009. "Inferring market power from retail deposit interest rates in the euro area," Bank of Finland Research Discussion Papers 27/2009, Bank of Finland.
    3. Florentina Paraschiv, 2013. "Adjustment Policy of Deposit Rates in the Case of Swiss Non-maturing Savings Accounts," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 3(3), pages 1-19.
    4. Geert Langenus, 2006. "Fiscal sustainability indicators and policy design in the face of ageing," Working Paper Research 102, National Bank of Belgium.
    5. repec:zbw:bofrdp:2009_027 is not listed on IDEAS
    6. Vajanne, Laura, 2009. "Inferring market power from retail deposit interest rates in the euro area," Research Discussion Papers 27/2009, Bank of Finland.

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    More about this item

    Keywords

    Demand deposits; ALM; risk management; arbitrage free pricing; flexible-affine term structure model; interest rate risk; IFRS 39; fair value accounting;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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