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

The interest rate is the price of capital and plays a important role in allocating funds. As one of the important economic variables, the Interest rates have affected all aspects of economic life. In the influence of the floating exchange rate system and the tide of the economic globalization, the volatility of the interest rates is increasing. The Interest risk is becoming one of the main risks of the commercial banks. After the market-oriented reform of interest rates, the volatility of our interest rate is gradually increasing. With the increase of interest rate volatility, the implied option risk of the commercial banks increases rapidly. AS the principles of the interest rate risk management of the Basel Committee, the implied option risk of the assets and liabilities of the commercial banks is becoming an important part of bank interest rate risk. Therefore, the research of the embedded option risk is very necessary.In this article, we discuss three aspects. The first one is the theory of commercial bank interest rate risk management. The second one is the embedded option risk of the commercial banks. The last is the methods of the management of the embedded optio risk. We discuss these issues based on the previous studies. This has practical significance on the risk management of the cmmercial banks.In the studies of theoretical, the article reviews the theory of the interest rate risk management of the cmmercial banks. There are four traditional interest rate risk management approach. They are Sensitivity gap analysis, Duration analysis, Simulation analysis and Value at Risk Analysis. These approaches Ignoring the existence of the option risk. The option risk can be divided into display options risk and implied option risk. The embedded option risk arises from the regulations and some contract with embedded option. So the commercial banks face a lot of implied option risk.In the study of the embedded option risk of commercial banks, we anlayzes the source of the embedded option risk. By the idea of the financial engineering, the implied option can be decomposed intio two parts. One is the vanilla securities and the other is options. Therefore, the value of the embedded option equal to the value of the vanilla securities plus the value of options. By the study of the option value, we can find that the value of the options become greater with a larger penalty.with the theory of the interest rate risk management, we find that the traditional duration and convexity model can more precisely measure and manage the interest rate risk. However, the traditional duration and convexity model is only suitable for the fixed cash flows in the future. So we use the effective duration and effective convexity measure based on the option-adjusted spreads, to measure the embedded option risk. There are four important models in the option-adjusted spread models. There are the risk-free interest rate term struture, interest rate dynamic model, monte carlo simulation and the early repayment model.Through the empirical analysis, we estimate that the option-adjusted spreads based on the difference rate of early repayment. With the empirical results, we find that the higher the rate of early repayment, the greater the option-adjusted spreads. At the same time, we also estimated the effective duration and effective convexity of the loan based on different rate of early repayment. With the rise of early repayment rate, the effective duration and effective convexity values become smaller.Finally, the article analyzes the advantages and disadvantages of the option-adjusted spread models. Also, we make some recommendations of the risk management of the implied option of the commercial bank.