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The art of managing interest rate risk in the banking book is becoming topical again with the recent release of the Basel Consultative document as well as the banks' need to generate interest income in a persistently low and flat interest rate environment. Interest rate risk in the banking book is traditionally managed by considering the tradeoff between short-term income volatility and the longer-term economic value of equity (EVE) volatility: the tradeoff between risk (of earnings and/or EVE decline due to adverse interest rate movement) and return (of net interest rate income and potential increase in EVE due to favourable interest rate movements). Although these are old and well-understood concepts, these risk vs return frameworks are at best implicit in many organisations, leaving room for suboptimisation. Another area of improvement is with respect to simplistic risk appetite frameworks, in many cases limited to sensitivity analysis (eg parallel shocks, etc), which can neither capture the true variety of interest rate movements nor be conceptualised. In this paper, we introduce a dynamic optimisation framework for explicitly managing interest rate risk and the return in the banking book. We also define the risk appetite in a manner that can be conceptualised and directly calibrated to an organisation's risk preferences and tolerances. [ABSTRACT FROM AUTHOR]

There is growing evidence that the interests of active managers and their investors are misaligned, as the average value added delivered to the latter by the former is less than zero after fees are deducted. Some commentators have concluded that it is impossible to correct this misalignment. This article argues both that much of this misalignment stems from diseconomies of scale in active manager value added and that this misalignment can be corrected when skill is present. It also presents a model that quantifies the trade-offs between the alignment improving measures it identifies. [ABSTRACT FROM AUTHOR]