Valuing The Withdrawal Option In Retail Cd Portfolios
Title - Alternative
J. Financ. Serv. Res.
A retail certificate of deposit (CD) is a bank-originated, fixed-rate, fixed-term, federally insured liability containing an option that allows the early withdrawal of funds by the depositor upon payment of a prespecified penalty. Failure to estimate the effects of withdrawals from a bank's CD portfolio results in inaccurate estimates of the value of its equity, as would failure to estimate prepayments from its mortgage portfolio. Using techniques from mortgage portfolio valuation, this article develops a method for valuing a portfolio of CDs that includes a model of early withdrawals. This method makes it possible to calculate an interest rate equivalent for the cost of the withdrawal option and to correctly measure interest rate risk. We present a brief case study from a small, Midwestern bank and a set of simulations over a variety of potential interest rate paths.
Journal of Financial Services Research
Gilkeson, J. H. and Ruff, C. K., "Valuing The Withdrawal Option In Retail Cd Portfolios" (1996). Faculty Bibliography. 1859.