The Study Of Management Of Interest Risk Based On Embedded Option In Commercial Bank

The market-oriented interest rate is an important link in the chain of the market-oriented finance of our country and its implementation step is speeding up with the expected ways. The market-oriented interest rate is the necessary requirement of the financial reformation and entrance to WTO. The market-oriented interest rate results in both the right of fund-pricing independently of the commercial bank and the main market risk. An inevitable problem is that on one hand commercial banks have more freedom to price in market conditions, one the other hand, interest rate fluctuates more and more frequently. Risk of interest rate has become the primary market risk.The paper discusses how to manage the interest rate risk based on embedded option effectively.First of all, the paper defines the risk-embedded option, figures out the forms of the embedded option in the assets and liabilities of the commercial banks and analyzes the main source of the interest risk-embedded option of our country at the present time. we select effective duration and convexity rather than the sensitivity gap method and modifying duration gap method as the measuring index, because the latter do not consider the influence on cash flow and market value of the assets and liabilities brought by embedded options.Then the paper selects effective duration as the measurement of embedded option. Ascertaining the option-adjusted spread is the key of calculating effective duration. The paper gives a particular analysis on the core module of the option-adjusted model, that is the module of making interest scenes and the module of option characteristic behavior. Combining the facts of our country the paper analyzes the applicability of the model. The paper simulates the process of calculating the effective duration and convexity with Hull and White's interest term structure and trinomial interest rate tree model.Finally, the paper give some advises on how to build an effective risk control mechanism to control interest rate risk-embedded option.