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Evaluating the validity of regulatory interest rate risk measures – a simulation approach

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  • Claußen, Catharina
  • Platte, Daniel

Abstract

This paper assesses the validity of changes in the economic value of equity (EVE) and the net interest incom (NII) as regulatory risk measures for a bank’s interest rate risk in the banking book. We develop a novel simulation approach and evaluate the measures retrospectively from the time of a bank’s default as a consequence of stressed market interest rates. Our results show that both measures significantly indicate inherent interest rate risk. We find the EVE to be a robust and conclusive risk measure, whereby the results concerning the NII measure are against the economic intuition, less robust, and might depend on the prevailing level of interest rates. Further, we derive critical values of quarterly changes in risk measures serving as indicators for substantial risk levels. Our findings validate the EVE and contribute to a thorough understanding of the risk measures.

Suggested Citation

  • Claußen, Catharina & Platte, Daniel, 2023. "Evaluating the validity of regulatory interest rate risk measures – a simulation approach," Journal of Banking & Finance, Elsevier, vol. 154(C).
    • Handle: RePEc:eee:jbfina:v:154:y:2023:i:c:s0378426623001383
    DOI: 10.1016/j.jbankfin.2023.106933
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    More about this item

    Keywords

    Interest rate risk; Banking regulation; Economic value; Net interest income; Stress testing;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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