Title: Optimal interest rate derivatives portfolio with controlled sensitivities

Authors: Konstantinos Kiriakopoulos, George Kaimakamis, Charalambos Botsaris

Addresses: Proton Bank, Capital Markets, 20 Amaliados Street, Athens, 11523, Greece. ' Hellenic Army Academy, 16673 Vari, Athens, Greece. ' Department of Regional Economic Development, Universitry of Central Greece, Leibadia, 32100, Greece

Abstract: In the interest rate market, the use of derivatives is necessary and can significantly influence the balance sheet of a bank. Moreover, in the light of the recent crisis, it became obvious the need for portfolios with specific and known risk characteristics. This paper proposes a method for constructing optimal portfolios of derivatives with specific risk/return characteristics in the interest rate market. The portfolios can include any interest rate derivative security such as bonds, swaps, caps, floors, swaoptions, CMS, etc. The optimal portfolios will have their risk sensitivities (delta, gamma, theta, etc.) within prespecified bands. In this way, the trade-off between risk and return will be controlled through the life of the portfolio avoiding unwanted risks. The method proposed is structural and dynamic so that it can fit to trading level, risk management level and senior management level. Moreover, the method can include VAR and CVAR techniques which are currently used in risk management.

Keywords: interest rates; derivatives; portfolio sensitivities; stochastic control; risks; returns; risk management; CVAR; conditional VAR; value at risk.

DOI: 10.1504/IJDSRM.2010.034675

International Journal of Decision Sciences, Risk and Management, 2010 Vol.2 No.1/2, pp.112 - 128

Published online: 14 Aug 2010 *

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