Duration of demand deposits in theory Mgr. Hana Džmuráňová doc. PhDr. Petr Teplý Ph.D. Institute of Economic Studies Faculty of Social Sciences Charles University in Prague ACFA (2015), VSE Prague

Outline of the presentation 1.Introduction 2.Duration of demand deposits in theory ALM and risk management of As&Ls Duration of demand deposits – risk management of demand deposits Market rate model Client rate model Volumes Replicating portfolio 3.Questions and answers

Introduction Maturing versus non-maturing products (assets and liabilities) A role of ALM Demand deposits – why it matters? Legal duration Effective duration Embedded options Importance in the economy Importance for bank sector in the Czech Republic Duration of demand deposits – how to derive

Demand deposits in the Czech Republic Source: CNB (2015) and Authors’ own calculations. In 6/2010 CNB reclassified app. CZK 90 bn of savings accounts from current accounts to savings accounts and other deposits redeemable on notice. Another reclassification took place also in 1/2013. Savings accounts versus current accounts

How to derive effective duration of demand deposits We need to know/estimate cash flows from demand deposits and their interest rate risk/characteristics How to do this: Replicating portfolio Time series analysis Survival analysis

Replicating portfolios Market rate model Client rate paid on demand deposits Volumes of demand deposits Portfolio of instruments with known duration DURATION of demand deposits

Market rate model - example Vašíček model: dm t = a(b-m t )dt + qdW t m t = benchmark market rate a = speed at which interest rate mean reverts to equilibrium q = volatility of the model W t = Wienner process, random process representing market risk factors b – mean

Deposit rate model d = f(d, m) d = deposit rate m = market rate Asymmetric adjustment and lagged reaction Long-run relationship and short-run relationship between market rates and deposit rates Assymetric adjustment models, cointegration

Volumes V = f(V, m, d, x) V = volume of demand deposits m = market rate d = deposit rate x = macroeconomic variable of a choice Log-normal distribution Maturity of demand deposits Interest rate sensitivity of volumes

Volumes long-term portfolio development  reinvestment

11 Replicating portfolio and duration Duration of demand deposits = duration of replicating portfolio Optimalization Pros and cons of replicating portfolios

Thank you for your attention and now it is a time for Q&A session.

Acknowledgements Financial support from: a)the Czech Science Foundation (project No. GA S) b)the Grant Agency of Charles University in Prague (project No ) c)and University of Economics in Prague (project No. VŠE IP100040) is gratefully acknowledged.

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