An Alternative Approach to Asset-Liability Management

Traditionally, the potential financial impact of interest rate movements has been evaluated through duration measures or through computer simulations. The duration measure approach is analytical, and focuses on changes in market value; the computer simulation approach is computational and focuses on income statement and balance sheet impacts. In this paper a complementary approach for projecting the earnings impact of asset-liability mismatch is derived. This approach, referred to as the mismatch-earnings formula (MEF) is analytical but focuses on income statement impact of interest rate movements. The MEF approach can be used to gain insight into ALM mismatch exposure, to estimate the expected earnings and volatility of earnings arising from a mismatch position, and to optimize portfolios.