Theoretical and Applied Economics (Jan 2008)
Interest Rate Risk Management using Duration Gap Methodology
Abstract
The world for financial institutions has changed during the last 20 years, and become riskier and more competitive-driven. After the deregulation of the financial market, banks had to take on extensive risk in order to earn sufficient returns. Interest rate volatility has increased dramatically over the past twenty-five years and for that an efficient management of this interest rate risk is strong required. In the last years banks developed a variety of methods for measuring and managing interest rate risk. From these the most frequently used in real banking life and recommended by Basel Committee are based on: Reprising Model or Funding Gap Model, Maturity Gap Model, Duration Gap Model, Static and Dynamic Simulation. The purpose of this article is to give a good understanding of duration gap model used for managing interest rate risk. The article starts with a overview of interest rate risk and explain how this type of risk should be measured and managed within an asset-liability management. Then the articles takes a short look at methods for measuring interest rate risk and after that explains and demonstrates how can be used Duration Gap Model for managing interest rate risk in banks.The world for financial institutions has changed during the last 20 years, and become riskier and more competitive-driven. After the deregulation of the financial market, banks had to take on extensive risk in order to earn sufficient returns. Interest rate volatility has increased dramatically over the past twenty-five years and for that an efficient management of this interest rate risk is strong required. In the last years banks developed a variety of methods for measuring and managing interest rate risk. From these the most frequently used in real banking life and recommended by Basel Committee are based on: Reprising Model or Funding Gap Model, Maturity Gap Model, Duration Gap Model, Static and Dynamic Simulation. The purpose of this article is to give a good understanding of duration gap model used for managing interest rate risk. The article starts with a overview of interest rate risk and explain how this type of risk should be measured and managed within an asset-liability management. Then the articles takes a short look at methods for measuring interest rate risk and after that explains and demonstrates how can be used Duration Gap Model for managing interest rate risk in banks.
