Estimating the value and interest rate risk of demand deposits in concentrated markets

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dc.contributor Aalto University en
dc.contributor Aalto-yliopisto fi Tynys, Lauri 2012-02-29T02:30:37Z 2012-02-29T02:30:37Z 2012
dc.description.abstract PURPOSE OF THE STUDY The purpose of this study is to determine the value and interest rate risk of funds deposited in demand deposit accounts under imperfect competition among banks. The value of a demand deposit is divided into two components, which are rent and liability. The former is defined as the profit bank receives from accepting demand deposits (by paying rates below the short-term market interest rate) and the latter as the nominal value of deposits minus the rent. The interest rate risk of demand deposits is measured by their sensitivity to shocks in the short-term market interest rate. The analysis in this thesis is carried out from the viewpoint of a case bank, which is a Finnish commercial bank, and the Finnish banking sector as a whole. DATA AND METHODOLOGY Historical data is needed in this thesis in order to estimate the demand functions for deposits and the processes of the variables. Most of the data series span from January 2006 to December 2010, totaling 60 monthly observations. The data was obtained from three sources: the case bank’s databases, Bank of Finland, and Statistics Finland. Monte Carlo simulation is used in generating the value and interest rate risk estimates. A majority of the variables are modeled as AR(2)-processes, whereas the short-term market interest rate is modeled using a one-factor stochastic Cox-Ingersoll-Ross model. Moreover, various assumptions concerning deposit balance dynamics are taken into account in the analysis of case bank, whereas the analysis of the whole banking sector is carried out only under AR(2) forecasted balances. RESULTS The results indicate that several variables measuring macroeconomic environment and market concentration play an important role in determining the demand function for demand deposits. Also, it is found that both the case bank and the Finnish banking sector as a whole exercise market power, as both of them are able to generate significant positive rents from accepting demand deposits. However, the magnitude of these rents varies a lot depending on the assumed deposit balance dynamics. The largest rent estimates are obtained assuming that future deposit balances evolve according to AR(2) forecasts, whereas under constant and decaying balances the rents are substantially lower. Finally, I find the interest rate risk of demand deposits to be significant, as their valuations are sensitive to short-term market rate shocks under all deposit balance dynamics covered. en
dc.format.extent 79
dc.format.mimetype application/pdf en
dc.language.iso en en
dc.title Estimating the value and interest rate risk of demand deposits in concentrated markets en
dc.type G2 Pro gradu, diplomityö fi Kauppakorkeakoulu fi School of Economics en
dc.contributor.department Department of Finance en
dc.contributor.department Rahoituksen laitos fi
dc.subject.keyword bank liability management
dc.subject.keyword market concentration
dc.subject.keyword demand deposits
dc.subject.keyword interest rate risk
dc.identifier.urn URN:NBN:fi:aalto-201203011263
dc.type.dcmitype text en
dc.programme.major Finance en
dc.programme.major Rahoitus fi
dc.type.ontasot Master's thesis en
dc.type.ontasot Pro gradu tutkielma fi
dc.subject.helecon rahoitus
dc.subject.helecon financing
dc.subject.helecon pankit
dc.subject.helecon banks
dc.subject.helecon vastuu
dc.subject.helecon responsibility
dc.subject.helecon korko
dc.subject.helecon interest
dc.subject.helecon riski
dc.subject.helecon risk
dc.subject.helecon markkinat
dc.subject.helecon markets
dc.ethesisid 12752 2012-02-07
dc.location P1 I

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