A Guide to Behavioural Modelling
First published:
ISBN: 978-1-78272-404-9
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Prepayment Risk Modelling for ALM, Finance and FTP: A Survival Model
Pierluigi Coriazzi and Lisa Signani
Introduction
Insights on Banks’ Recourse to Behavioural Models from a Focused IRRBB Stress Test
Implementing Regulatory Guidance on IRRBB Behavioural Models: Challenges and Opportunities
The Stakeholders of Interest Rate Risk Behavioural Models
Governance of Behavioural Models
The Nature of IRRBB and Typical Metrics Employed
A Framework for Developing NMD Behavioural Models
The Literature on NMD Behavioural Models
Interest Rate Risk of Non-maturity Bank Accounts: From Marketing to Hedging Strategy
NMDs and IRRBB: A Methodological Proposal for a Behavioural Model
NMD Modelling: A Financial Wealth Allocation Approach
A Benchmark Framework for NMDs: An Application
NMD Behavioural Models Used in Marketing
The Validation of NMD Behavioural Models
The Choice of Maturity Profile in NMD Behavioural Models
Acknowledging the Elephant in the Room: The Mismatch Centre
Prepayment Risk Modelling for ALM, Finance and FTP: A Survival Model
Modelling of Prepayment on Fixed Rate Residential Mortgages: A Logistic Regression Approach
A Simple Approach to Modelling Prepayment Events
Integrating Credit Risk within the ALM Framework
Modelling Committed Credit Lines
Accounting of the Sight Deposit and Hedging
In many jurisdictions, including that of Italy, customers can repay or refund their mortgages without penalty at any time; where penalties apply, prepayment is a less relevant risk. Prepayment risk affects both fixed and floating rate loans, although interest rate risk is minor for the latter compared to the former, for floating rates loans it is not negligible when considering the spread component.
From the financial point of view, a loan/mortgage subjected to early redemption risk is similar to a callable bond issued by the customer and underwritten by the bank: customers should exercise the prepayment option to minimise the present value of their loans. However, option pricing theory can be of limited use in the assessment of prepayment risk, especially for retail loans, as the average financial knowledge of participants is often quite low and the market efficiency theory frequently does not hold. Prepayment also affects floating rate loans where rational exercise arguments are not directly applicable. For these reasons, prepayment estimation is frequently approached through the use of behavioural models.
The graph in Figure 16.1 shows the historical prepayment rate for
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