The Valuation and Hedging of Non-Maturity Deposits: Frequently Asked Questions

Donald R. van Deventer[1]

• First Version: October 31, 2022
• This Version: January 10, 2023

Abstract

A recent paper by Jarrow, Melnikov, Sherman, van Deventer and Zorn [2022] showed how the discrete time valuation formulas for non-maturity deposits, following Jarrow and van Deventer [1996], can be extended and generalized using risk-neutral valuation. These formulas apply for any number of interest rate risk factors and any form of interest rate volatility as long as the no arbitrage constraints of Heath, Jarrow and Morton[1992] apply. The resulting formulas often have closed form solutions. Even when those closed form solutions become more complex, one can easily calculate a numerical solution that requires only the existing output from a Heath, Jarrow and Morton simulation of risk-free yields plus regression equations that explain the response of deposit rates and balances to changes in the economic environment going forward.

The paper generated a number of thoughtful questions from practitioners and academics.  In this note, we provide brief answers to six of the questions received.

The full text of this paper is available here:

Footnotes:

[1] SAS Institute Inc.  Copyright 2023 by SAS Institute Inc.  All rights reserved.