Post by Sapphire Capital on Oct 16, 2008 22:21:18 GMT 4
Joint Interest Rate Risk Management of Balance Sheet and Hedge Portfolio in a Present Value Perspective
Simone Farinelli
UBS
Paolo Vanini
University of Zurich - Swiss Banking Institute (ISB); Zurich Cantonal Bank
The Icfai University Journal of Financial Risk Management, Vol. V, No. 3, pp. 61-89, September 2008
Abstract:
We present a multi-period mean-variance optimization program, which allows for a joint optimization of the balance and off-balance sheet. Our first finding is the proof of a conjecture of Li and Ng (2000) and Leippold et al., (2003 and 2004) about the equivalence of the original non-separable mean-variance problem and its embedding into a higher dimensional separable problem. We further prove that given a time independent term structure, the one-period and the multi-period problem are equivalent. If the best forecast of the interest rates is the forward rate, we show that it is then optimal to mimic the benchmark strategy. We apply the model first to United Bank of Switzerland (UBS) data and show that the myopic models are not acceptable for key rate delta profile management. Then, we calculate present value of a portfolio for 2005. It follows that the optimal dynamic portfolio strategy leads to a return of 3.12% compared to 2.6% of the myopic model.
papers.ssrn.com/sol3/papers.cfm?abstract_id=1265942
Simone Farinelli
UBS
Paolo Vanini
University of Zurich - Swiss Banking Institute (ISB); Zurich Cantonal Bank
The Icfai University Journal of Financial Risk Management, Vol. V, No. 3, pp. 61-89, September 2008
Abstract:
We present a multi-period mean-variance optimization program, which allows for a joint optimization of the balance and off-balance sheet. Our first finding is the proof of a conjecture of Li and Ng (2000) and Leippold et al., (2003 and 2004) about the equivalence of the original non-separable mean-variance problem and its embedding into a higher dimensional separable problem. We further prove that given a time independent term structure, the one-period and the multi-period problem are equivalent. If the best forecast of the interest rates is the forward rate, we show that it is then optimal to mimic the benchmark strategy. We apply the model first to United Bank of Switzerland (UBS) data and show that the myopic models are not acceptable for key rate delta profile management. Then, we calculate present value of a portfolio for 2005. It follows that the optimal dynamic portfolio strategy leads to a return of 3.12% compared to 2.6% of the myopic model.
papers.ssrn.com/sol3/papers.cfm?abstract_id=1265942