| The embedded options refer to options caused by payments or withdrawal inadvance, which brings commercial banks option risk and influence the commercialbank interest rate risk management. The Basel Committee has clearly pointed out inthe Principles of Interest Rate Risk Management that there is an additional and moreimportant risk embedded in banks’ balance sheets which is called embedded optionrisk. The embedded option can change the cash flow of banks’ assets andliabilities, increasing the difficulty of interest rate risk measurement and management.Because of China’s long-term practice of interest rate control, commercial banksgenerally do not realize the importance of embedded option risks. With thecontinuous progress of interest rate marketization, frequency and amplitude ofinterest rate volatility have been increasing significantly, which makes China’scommercial banks have more embedded options in their balance sheets. Based onthe above theoretical and practical background, research on the embedded option’simpact on interest rate risk management of commercial banks in China has aprofound theoretical basis and profound realistic significance.My research started from the literature study of the domestic and foreign relatedpapers, finding that most of them mainly focused on discussing the implied optionpricing method and technology, especially in recent years. While fewresearchers paid more attention to the embedded option prices accurately todiscuss the influence of embedded option on interest rate riskmanagement. Thus, following the logic of risk identification, risk measurementand risk management, firstly my research analyses how embedded option affectinterest rate risk management of China’s commercial banks theoretically. Secondly Iused Option Adjusted Spread Method to quantify the embedded option risk, based onwhich I calculated the duration and convexity of commercial banks’ assets andliabilities to push my research further.Using August18,2014’s data of20bonds exchanged in SSE, my papersuccessfully bootstripped the zero-coupon yield curve used as the term structureof risk-free rate of return. And then my paper chose CIR model as the dynamicstructure of interest rate which reflects the mean-reversion characteristics of interestrate, using January4,2012to2014October31day7061M-Shibor benchmarkinterest rates(from January4,2012to2014October31) as the sample, withintroduction of the GARCH (1,1) model to reduce heteroscedasticity causing data cluster effect, to get the smooth interest rate dynamic term structure, and thesimulation test verifies that the term structure can accurately reflect the real interestrate changes. Thinking of the actual situation of China’s early repayment speeding up,the paper used150%PSA model as the early payment behavior model. Combinedwith the term structure of interest rates and the Monte Carlo simulation the paperused the MATLAB software to calculate interest rates’ moving paths, andthus determined the cash flow on each path. Integrating the above steps, the paperused MATLAB’s cycle calculation program that make cash flows on eachpath discounted by the risk-free interest rate plus certain basic points. The basicpoints that can make real value equal to theoretical value is the very OAS.Finally, the paper used this OAS to calculate the duration and convexity consideringand not considering embedded options respectively. Comparing these durations andconvexities found that the embedded option do reduce bank assets and liabilities ofthe effective duration and convexity, and then make the means of interest rate riskmanagement of duration and convexity matching fail. Which more serious isthat existence of embedded options may make effective convexity negative. Thenegative convexity of assets is harmful for interest rate risk managementof commercial banks. In view of the conclusion, this paper still put forward somesuggestions from the aspects of internal management, taking control of earlypayment behavior and reform of commercial banks in China. |
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