Non‐maturity Deposit Valuation and Hedging Non-maturity Deposit Valuation and Hedging Avistatilien Arvostus Ja Niiden Korkoriskin Suojaaminen Mat-2 Applied Mathematics Professor Ahti Salo

Usually non-maturity deposits form a considerable part of banks' assets and funding and thus hedging the interest rate risk of them is important. However, the available research addressing non-maturity deposit valuation is very limited. In this Thesis, we compare models for estimating the deposit rate and stock evolution and suggest suitable hedging possibilities for non-maturity deposits. Non-maturity deposits have no stated maturity and they can be withdrawn at any time. However, they often remain with the financial institution for extended periods of time. The previous studies show that the deposit rate follows usually a short market rate, but with stickiness and asymmetric mean reversion. The stock of the non-maturity deposits tend to be highest when the interest rates are low because then the opportunity cost is low. The value of the non-maturity deposit is computed with the Jarrow-Van Deventer –model and the interest rate risk is analysed with the duration and average life of the non-maturity deposits. We compare the different hedging methods by simulating the cash flows with the Vasiček model and the error correction model for the deposit rate. The error correction model estimates better the deposit rate of interest than ordinary dynamic models. When the error correction model is modified, it can explain also the asymmetric adjustment of the rate. The deposit stock has a strong time trend and it also depends on the market rate. The non-maturity deposits have a very long duration of over 20 years and an average life over 5 years. From the hedging methods, deposit swap was found to be the most efficient one when considering variances. However, the plain vanilla swap seems to be almost as efficient, but a more simple and liquid way to hedge the non-maturity deposits.