The Study On The Embedded Option Risk's Measurement Of Loan For Commercial Bank

The market-oriented interest rate is the necessary requirement of the financial reformation and entrance to the world economic system, and its implementation step is speeding up in our country. An inevitable problem is that, interest rate fluctuates more and more frequently, risk of interest rate has become the primary market risk. Embedded option risk is one kind of interest rate. This paper chiefly discussed the problem that how the embedded option risk can be measured effectively.First of all, the paper defines the embedded option risk, figures out the main forms of the embedded option in the assets and liabilities of the commercial banks and analyzes the embedded option risk's influence on the management of commercial bank. We select effective duration rather than the Macaulay duration method as the embedded option risk measuring index, because the latter do no consider the influence on cash flow and market value of the assets and liabilities brought by embedded options. Ascertaining the option-adjusted spread is the key of calculating effective duration. The paper analyzes the calculation of the option adjusted spread, then points out that the selections of interest rate path calculation and prepayment model are the critical parts.The paper selects different mortgage samples at home and abroad, and selects different term structures of interest rate and prepayment models each other, calculates their effective durations when they contain embedded option. At last, the paper discusses the differences between embedded option risk measurements of mortgage loans at home and abroad, and gives some advises on how to build an effective risk control mechanism to control embedded option risk.