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Univerzita Karlova v Praze Fakulta sociálních věd Institut ekonomických studií Název disertační práce/ Dissertation title Interest Rate Risk and Liquidity Risk of Banking Books in the Czech Republic Anglický překlad / Title in English Interest Rate Risk and Liquidity Risk of Banking Books in the Czech Republic Autor/ka/ Author Mag. Hana Džmuráňová Rok zpracování/ Year 2021 Školitel / Advisor Doc. Ing. Zdeněk Tůma CSc. Počet stran / No. of pages 197 Abstract in English The thesis Interest Rate Risk and Liquidity Risk of Banking Books in the Czech Republic deals with the management of interest rate risk and liquidity risk stemming from the core banking system purpose - the maturity transformation. Across five articles, we provide comprehensive theoretical description, regulatory background, and develop models for embedded behavioural options of client products such as non-maturity deposits, with special focus on savings accounts in the Czech Republic in one of our case studies, or loans with prepayment option. We apply our models on the major Czech and Slovak banks and we calculate the exposure of those banks to interest rate risk in terms of regulatory guidelines. We derive that all banks in our analysis are positioned to benefit when interest rates increase as demand deposits like current accounts are...

Описан механизм управления инновационными проектами на основе венчурного инвестирования, позволяющий принимать решения о выборе инновационных проектов, а также корректировать инвестиционную стратегию с учетом возникающих изменений. Механизм включает в себя пять процедур: предварительный отбор проектов в соответствии ключевыми требованиями; оценку ожидаемой коммерческой эффективности проекта, характеризующей его доходность с учетом риска, присущего различным стадиям инновационного процесса; комплексную экспертную оценку проекта по качественным и количественным критериям с использованием модификации аналитического иерархического процесса; формирование портфеля проектов с использованием алгоритма последовательного распределения инвестиционных ресурсов на основе приоритетов проектов с учетом финансовых ограничений; пересмотр портфеля проектов с учетом возникающих изменений. Предложенный механизм может найти практическое применение как институтами инновационного развития региона, так и другими институциональными и неинституциональными инвесторами., The article describes a mechanism of the innovative projects management based on venture investment, which allows making decisions on the choice of innovative projects, as well as adjusting the investment strategy taking into account the emerging changes. The mechanism includes five procedures: preliminary selection of projects in accordance with key requirements; assessment of the expected commercial efficiency of the project, characterizing its profitability with allowance for the risk inherent in various stages of the innovation process; complex expert assessment of the project with respect to qualitative and quantitative criteria using a modification of the analytic hierarchy process; formation of a portfolio of projects using an algorithm for sequential distribution of investment resources based on project priorities, taking into account financial constraints; transformation of the project portfolio taking into account the emerging changes. The proposed mechanism can find practical application both by the institutions of innovative development of the region and by other institutional and non-institutional investors.

Tawfik AZRAK Sorumlu yazar: Ankara Sosyal Bilimler Üniversitesi, Uluslararası İslam Ekonomisi ve Finansı Uygulama ve Araştırma Merkez. E-posta: tawfik.azrak@asbu.edu.tr, https://orcid.org/0000-0001-9059-2115 Dr. Hazimi FOZİAH Ekonomi ve Yönetim Bilimleri Fakültesi, Universiti Sultan Zainal Abidin, Malezya. E-posta: nikhazimi@unisza.edu.my, https://orcid.org/0000-0002-1001-5877 Structured Products could be defined as savings or investment products in which the return is linked to an underlying asset with pre-defined features such as the maturity date, coupon date, capital protection level (SMR Wealth Management). Islamic structured products are essentially Shariah-compliant structured products. They bear similarities to conventional products in terms of purpose, economic benefits and basic structural features. The difference being that Islamic structured products adhere to Shariah principles by avoiding riba (usury), gharar (uncertainty), zulm (injustice), and operate holistically in a Shariah-compliant manner. This includes utilizing Shariah contracts approved by the Shariah Advisory Council of the Central Bank of Malaysia to structure the investment and contains underlying assets that are permissible by Shariah. Despite having been introduced into the industry since its establishment, implementing Islamic structured products have many Shariah issues. Using in-depth analyses of both the literature and several case studies for structured products in Islamic banks in Malaysia, this paper analyzes and assesses the most important Shariah issues surrounding Islamic structured products in Malaysia. Our findings confirm that the current implementation of Malaysian structured products continues to possess a number of Shariah issues, which need to be corrected by both the banks and the industry in order to have fully Shariah-compliant structured products to be operational in the market. Yapılandırılmış Ürünler, getirinin vade tarihi, kupon tarihi, sermaye koruma seviyesi (SMR Varlık Yönetimi) gibi önceden tanımlanmış özelliklere sahip bir dayanak varlık ile bağlantılı olduğu tasarruf veya yatırım ürünleri olarak tanımlanabilir. İslami yapılandırılmış ürünler aslında İslam hukukuna uyumlu yapılandırılmış ürünlerdir. Bu ürünler amaç, ekonomik faydalar ve temel yapısal özellikler açısından geleneksel ürünlere benzerlik taşırlar. Aralarındaki fark, İslami yapılandırılmış ürünlerin riba (faiz), gharar (belirsizlik), zulm (adaletsizlik)’den kaçınarak İslam hukuku ilkelerine bağlı kalması ve bu ilkelerle uyumlu şekilde bir bütün olarak çalışmasıdır. Bu, yatırımı yapılandırmak için Malezya Merkez Bankası Şer’i Danışma Kurulu tarafından onaylanan İslam hukuku sözleşmelerinin kullanılmasını ve İslam hukuku tarafından izin verilen dayanak varlıkları içerir. Kurulduğu günden bu zamana kadar sektöre kazandırılmasına rağmen, İslami yapılandırılmış ürünlerin uygulamalarının birçok İslam hukuku sorunu var. Bu çalışma Malezya'daki İslami bankalarda yapılandırılmış ürünler için hem literatürün hem de çeşitli vaka çalışmalarının derinlemesine analizlerini kullanarak bu ürünlerin İslam hukuku açısından en önemli sorunlarının analizini ve değerlendirmesini yapmaktadır. Çalışmanın bulguları, Malezya’da kullanılan yapılandırılmış ürünlerin mevcut uygulamasının İslam hukuku açısından bir dizi sorununa sahip olduğunu, bu ürünlerin piyasada İslam hukukuna tamamen uyumlu şekilde faaliyete göstermesi için mevcut sorunların hem bankalar hem de endüstri tarafından düzeltilmesi gerekliliğini ortaya koymaktadır.

The shift from defined benefit (DB) to defined contribution (DC) is pervasive among pension funds, due to demographic changes and macroeconomic pressures. In DB all risks are borne by the provider, while in plain vanilla DC all risks are borne by the beneficiary. However, for DC to provide income security some kind of guarantee is required. A minimum guarantee clause can be modeled as a put option written on some underlying reference portfolio and we develop a discrete model that selects the reference portfolio to minimize the cost of a guarantee. While the relation DB–DC is typically viewed as a binary one, the model shows how to price a wide range of guarantees creating a continuum between DB and DC. Integrating guarantee pricing with asset allocation decision is useful to both pension fund managers and regulators. The former are given a yardstick to assess if a given asset portfolio is fit-for-purpose; the latter can assess differences of specific reference funds with respect to the optimal one, signaling possible cases of moral hazard. We develop the model and report numerical results to illustrate its uses.

This paper develops a dynamic option-based model for the valuation of rental and other similarly structured lease contracts under the conditions of uncertainty that is then solved by statistical simulation (Monte Carlo). The motivation, research background and methodology of the paper follow up on a previously published general firm-theoretical approach by the author, who takes an interdisciplinary approach to apply the model in this particular context. It is shown that due to the path dependency of the problem, Monte Carlo is an appropriate and practical tool for analyzing embedded options, incident in most rental and lease relationships, and can be used as a major determinant of their value. In addition to its basic valuation function, exploitable for business acquisition or lease contracting purposes, this Monte Carlo model is very well disposed for various microeconomic analyses. Accordingly, we demonstrate the particular impacts and sensitivities of contractual party-specific, as well as environmental, factors including parties’ transaction costs, information asymmetry and enforceability of legal claims.

Este artigo apresenta um modelo para determinação do passivo e do risco financeiro associado às opções implícitas atreladas a produtos de previdência complementar no Brasil (PGBL/VGBL). Propõe-se uma modelagem específica para o problema através da caracterização da opção financeira embutida nos produtos de previdência com possibilidade de conversão do saldo final do participante em benefício vitalício sob termos predeterminados. Modelam-se também as características financeiras desse passivo, tais como duração, convexidade e fluxo de caixa equivalentes, que podem ser utilizadas para otimização da carteira de ativos associada a essa obrigação. Por fim, apresentam-se os resultados e a análise de sensibilidade da aplicação da modelagem proposta para o caso específico de um fundo de previdência complementar aberta.This paper presents a model to assess liabilities and financial risks created by options embedded in retirement related investment products in Brazil (PGBL/VGBL). A specific model that characterizes the financial option embedded in insurance products is presented. These products guarantee the conversion of final participant balance in retirement income at predefined terms. Financial characteristics of this liability such as duration, convexity and equivalent cash flows are also modeled. These characteristics can be useful as inputs to optimization models for the assets portfolio backing such liabilities. Finally, results and sensitivity analysis of an application of the model to a Brazilian open-end retirement related fund are presented.

Este artigo apresenta um modelo para determinação do passivo e do risco financeiro associado às opções implícitas atreladas a produtos de previdência complementar no Brasil (PGBL/VGBL). Propõe-se uma modelagem específica para o problema através da caracterização da opção financeira embutida nos produtos de previdência com possibilidade de conversão do saldo final do participante em benefício vitalício sob termos predeterminados. Modelam-se também as características financeiras desse passivo, tais como duração, convexidade e fluxo de caixa equivalentes, que podem ser utilizadas para otimização da carteira de ativos associada a essa obrigação. Por fim, apresentam-se os resultados e a análise de sensibilidade da aplicação da modelagem proposta para o caso específico de um fundo de previdência complementar aberta. This paper presents a model to assess liabilities and financial risks created by options embedded in retirement related investment products in Brazil (PGBL/VGBL). A specific model that characterizes the financial option embedded in insurance products is presented. These products guarantee the conversion of final participant balance in retirement income at predefined terms. Financial characteristics of this liability such as duration, convexity and equivalent cash flows are also modeled. These characteristics can be useful as inputs to optimization models for the assets portfolio backing such liabilities. Finally, results and sensitivity analysis of an application of the model to a Brazilian open-end retirement related fund are presented.

The first part of this thesis is devoted to the study of an Affine Term Structure Model (ATSM) where we use Wishart-like processes to model the stochastic variance-covariance of interest rates. This work was initially motivated by some thoughts on calibration and model risk in hedging interest rates derivatives. The ambition of our work is to build a model which reduces as much as possible the noise coming from daily re-calibration of the model to the market. It is standard market practice to hedge interest rates derivatives using models with parameters that are calibrated on a daily basis to fit the market prices of a set of well chosen instruments (typically the instrument that will be used to hedge the derivative). The model assumes that the parameters are constant, and the model price is based on this assumption; however since these parameters are re-calibrated, they become in fact stochastic. Therefore, calibration introduces some additional terms in the price dynamics (precisely in the drift term of the dynamics) which can lead to poor P&L explain, and mishedging. The initial idea of our research work is to replace the parameters by factors, and assume a dynamics for these factors, and assume that all the parameters involved in the model are constant. Instead of calibrating the parameters to the market, we fit the value of the factors to the observed market prices.A large part of this work has been devoted to the development of an efficient numerical framework to implement the model. We study second order discretization schemes for Monte Carlo simulation of the model. We also study efficient methods for pricing vanilla instru- ments such as swaptions and caplets. In particular, we investigate expansion techniques for prices and volatility of caplets and swaptions. The arguments that we use to obtain the expansion rely on an expansion of the infinitesimal generator with respect to a perturbation factor. Finally we have studied the calibration problem. As mentioned before, the idea of the model we study in this thesis is to keep the parameters of the model constant, and calibrate the values of the factors to fit the market. In particular, we need to calibrate the initial values (or the variations) of the Wishart-like process to fit the market, which introduces a positive semidefinite constraint in the optimization problem. Semidefinite programming (SDP) gives a natural framework to handle this constraint.The second part of this thesis presents some of the work I have done on the hedging of interest rate risk in ALM. This work was motivated by the business at Cr ́edit Agricole S.A. and in particular by the Financial Division of the bank. The purpose of this part of the dis- sertation is twofold. First we want to communicate on a field of Finance which is less known by the mathematical finance community, and presents some interesting modeling challenges. Secondly we try to present an original approach to modeling and hedging interest rate risk.Chapter 6 is an attempt to formalize some of concepts that are used in practice in ALM. We recall some of the key concepts such as the schedule of an asset or a liability and the interest rate gap, and introduce a new concept : the notion of envelope. This concept will look familiar to people used to derivatives pricing, and the hedging of the interest rate riskof an asset or a liability (closing the gap using the language of ALM) is very similar to the hedging of an option. The remaining chapters present the results of the work we have done in three different projects.; Ce mémoire présente une partie du travail de recherche que j’ai effectué dans le cadre de ma thèse. Ce travail a été principalement effectué durant ma permanence au Groupe de Recherche Opérationnelle du Crédit Agricole. Etant donné le contexte dans lequel j’ai conduit mon travail de thèse, celui-ci a été principalement inspiré, et parfois meme directement motive par les besoins concrets des équipes opérationnelles. Le document contient deux par- ties qui sont indépendantes, et néanmoins représentent deux faces de la meme activité: la couverture du risque de taux d’intéret. Dans la première partie du document on étudie un modèle affine de la dynamique de la courbe des taux, ou un processus affine dans l’espace des matrices semidéfinies positives de type Wishart est utilis ́e pour modéliser la dynamique de la variance-covariance entre les taux d’intéret. L’ambition de notre travail est la construction d’un modèle qui fournisse une couverture globale et robuste des risques d’un book de produits exotiques de taux. Ce travail a conduit `a une pr ́e-publication [AAP14]. La deuxième partie du document est dédiée `a la couverture du risque de taux dans la gestion actif-passif du bilan d’une banque. L’objectif de cette seconde partie est de formaliser les principaux concepts qui sont utilisés en pratique dans ce domaine.

The first part of this thesis is devoted to the study of an Affine Term Structure Model (ATSM) where we use Wishart-like processes to model the stochastic variance-covariance of interest rates. This work was initially motivated by some thoughts on calibration and model risk in hedging interest rates derivatives. The ambition of our work is to build a model which reduces as much as possible the noise coming from daily re-calibration of the model to the market. It is standard market practice to hedge interest rates derivatives using models with parameters that are calibrated on a daily basis to fit the market prices of a set of well chosen instruments (typically the instrument that will be used to hedge the derivative). The model assumes that the parameters are constant, and the model price is based on this assumption; however since these parameters are re-calibrated, they become in fact stochastic. Therefore, calibration introduces some additional terms in the price dynamics (precisely in the drift term of the dynamics) which can lead to poor P&L explain, and mishedging. The initial idea of our research work is to replace the parameters by factors, and assume a dynamics for these factors, and assume that all the parameters involved in the model are constant. Instead of calibrating the parameters to the market, we fit the value of the factors to the observed market prices.A large part of this work has been devoted to the development of an efficient numerical framework to implement the model. We study second order discretization schemes for Monte Carlo simulation of the model. We also study efficient methods for pricing vanilla instru- ments such as swaptions and caplets. In particular, we investigate expansion techniques for prices and volatility of caplets and swaptions. The arguments that we use to obtain the expansion rely on an expansion of the infinitesimal generator with respect to a perturbation factor. Finally we have studied the calibration problem. As mentioned before, the idea of the model we study in this thesis is to keep the parameters of the model constant, and calibrate the values of the factors to fit the market. In particular, we need to calibrate the initial values (or the variations) of the Wishart-like process to fit the market, which introduces a positive semidefinite constraint in the optimization problem. Semidefinite programming (SDP) gives a natural framework to handle this constraint.The second part of this thesis presents some of the work I have done on the hedging of interest rate risk in ALM. This work was motivated by the business at Cr ́edit Agricole S.A. and in particular by the Financial Division of the bank. The purpose of this part of the dis- sertation is twofold. First we want to communicate on a field of Finance which is less known by the mathematical finance community, and presents some interesting modeling challenges. Secondly we try to present an original approach to modeling and hedging interest rate risk.Chapter 6 is an attempt to formalize some of concepts that are used in practice in ALM. We recall some of the key concepts such as the schedule of an asset or a liability and the interest rate gap, and introduce a new concept : the notion of envelope. This concept will look familiar to people used to derivatives pricing, and the hedging of the interest rate riskof an asset or a liability (closing the gap using the language of ALM) is very similar to the hedging of an option. The remaining chapters present the results of the work we have done in three different projects.; Ce mémoire présente une partie du travail de recherche que j’ai effectué dans le cadre de ma thèse. Ce travail a été principalement effectué durant ma permanence au Groupe de Recherche Opérationnelle du Crédit Agricole. Etant donné le contexte dans lequel j’ai conduit mon travail de thèse, celui-ci a été principalement inspiré, et parfois meme directement motive par les besoins concrets des équipes opérationnelles. Le document contient deux par- ties qui sont indépendantes, et néanmoins représentent deux faces de la meme activité: la couverture du risque de taux d’intéret. Dans la première partie du document on étudie un modèle affine de la dynamique de la courbe des taux, ou un processus affine dans l’espace des matrices semidéfinies positives de type Wishart est utilis ́e pour modéliser la dynamique de la variance-covariance entre les taux d’intéret. L’ambition de notre travail est la construction d’un modèle qui fournisse une couverture globale et robuste des risques d’un book de produits exotiques de taux. Ce travail a conduit `a une pr ́e-publication [AAP14]. La deuxième partie du document est dédiée `a la couverture du risque de taux dans la gestion actif-passif du bilan d’une banque. L’objectif de cette seconde partie est de formaliser les principaux concepts qui sont utilisés en pratique dans ce domaine.

The aim of this thesis is to investigate about the quantitative models used for pricing and managing life insurance risks. It was done analyzing the existing literature about methods and models used in the insurance field in order to developing (1) new stochastic models for longevity and mortality risks and (2) new pricing functions for life insurance policies and options embedded in such contracts. The motivations for this research are to be searched essentially in: (1) a new risk-based solvency framework for the insurance industry, the so-called Solvency II project, that will becomes effective in 2013/2014; (2) a new IAS/IFRS fair value-based accounting for insurance contracts, the so-called IFRS 4 (Phase 2) project (to be approval); (3) more rigorous quantitative analysis required by the industry in pricing and risk management of life insurance risks. The first part of the thesis (first and second chapters) contains a review of the quantitative models used for interest rates and longevity/mortality modeling. The second part (remaining chapters) describes new methods and quantitative models that it thinks could be useful in the context of pricing and insurance risk management.

This article gradually highlights the main problems that an insurance company has to face when issuing complex life insurance contracts with embedded options, and presents the basic principles that can be applied in order to price them. The article is based on some conferences that the author gave as invited speaker at the Austrian Workshop on Asset Liability Management in Insurance (Wien, 2004), the Workshop on Life Insurance Fair Valuation (Lyon, 2005), the Annual Meeting of the Swiss Association of Actuaries (Lausanne, 2006), the 9th Spanish-Italian Congress of Financial and Actuarial Mathematics (Alcalá de Henares, 2006), and at the University of Ljubljana (2007).

Issuances of perpetual risky debt are often motivated by capital requirements for financial institutions. However, observed market practice indicates that actual maturity equals first possible call date. We analyze callable risky perpetual debt including an initial protection period before the debt may be called. To this end we develop European barrier option pricing formulas in a Black and Cox (1976) environment. The total market value of debt including the call option is expressed as a portfolio of barrier options and perpetual debt with a time dependent barrier. We analyze how the issuer’s optimal bankruptcy decision is affected by the existence of the call option using closed-form approximations. In accordance with intuition, our model quantifies the increased coupon and the decreased bankruptcy level caused by the embedded option. We show that the option will be exercised even at fairly low asset levels at the time of expiry.

This is the author's version of the article: "Callable risky perpetual debt with protection period" European Journal of Operational Research, Volume 207, Issue 1, 16 November 2010, Pages 391–400 Issuances in the USD 260 Bn global market of perpetual risky debt are often motivated by capital requirements for financial institutions. We analyze callable risky perpetual debt emphasizing an initial protection (‘grace’) period before the debt may be called. The total market value of debt including the call option is expressed as a portfolio of perpetual debt and barrier options with a time dependent barrier. We also analyze how an issuer’s optimal bankruptcy decision is affected by the existence of the call option by using closed-form approximations. The model quantifies the increased coupon and the decreased initial bankruptcy level caused by the embedded option. Examples indicate that our closed form model produces reasonably precise coupon rates compared to numerical solutions. The credit-spread produced by our model is in a realistic order of magnitude compared to market data.

Embedded options arise in many tax-related decisions because of the ability to subsequently alter one's choices in response to changing conditions. This article analyzes one type of embedded option that is especially amenable to being modeled and that is of widespread interest: the decision to contribute to a traditional or Roth IRA, where the embedded option is associated (i.e., a traditional IRA contribution) might be incorrectly rejected when the option is ignored.

This dissertation empirically examines refunding decisions employed by issuers of tax-exempt bonds. Callable bonds contain embedded call options by virtue of provisions in bond indentures that permit the issuing firm to buy back the bond at a predetermined strike price. Such an embedded American call option has two components to its value, the intrinsic value and the time value. The issuer can realize at least as much as the intrinsic value by exercising immediately, when the option is in-the-money. Usually it is optimal for the holder of an in-the money American option to wait rather than exercise immediately, because the option has time value. It is rational for the holder to exercise the option when the total value of the option is no more than the intrinsic value. Option pricing theory can be used to identify two sub-optimal refunding strategies: those that refund too early, and those that refund too late. In such cases the holder incurs losses. I analyze the refunding decisions for two different samples of tax-exempt bonds issued between 1986 and 1993: the first consists of 2,620 bonds that are called, and the second contains 23,976 bonds that are never called. The generalized Vasicek (1977) model in the Heath, Jarrow, and Morton (1992) framework is used to construct binomial trees for interest rates, bond prices, and call option prices. The option pricing lattice is then used to compute the loss in value from sub-optimal refunding strategies, refunding efficiency, and months from optimal time for bonds in these two samples. Results suggest that sub-optimal refunding decisions cause losses to the issuers, which are present across bond and issuer characteristics. For the pooled sample of 26,596 bonds, the loss in value from sub-optimal refunding decisions totaled $7.2 billion, amounting to a loss of about 1.75% of total principal amount. Results indicate that issuers either wait too long to refund or never refund and cannot realize the present value saving of switching a high coupon bond with a low coupon bond, over a longer period of time. These results critically depend on the assumptions of underlying term structure model and are sensitive to model calibrated parameter values. Ph. D.