Analysis Of The Application Of VaR In Chinese Commercial Banks’Interest Rate Risk Measurement

Commercial banks, considered as the core of modern financial system, are operating a variety of businesses as well as operating risks. The level of risk management of commercial banks has great influence in the financial sector and even the safety of the modern economy. Interest rate risk management began in the1950s with a short history, and it has formed a relatively complete system in western countries. Because of interest rate controlled for many years in China and loan problems, people hardly paid any attention to interest rate risk management. It is necessary to introduce advanced interest rate risk management approach. In addition, interest income is still the main source of most of our commercial banking earning, it means a lot to manage interest rate risk well for both income of commercial banks and operating stability. With carried out of the interest rate marketization and central bank adjust interest rates frequently in the recent years, interest rate fluctuations and the frequency will be increased. The banks’ own development and change of the external environment requires the improvement of China’s commercial banks on interest rate risk management.VaR is widely used by western countries because of its advantages. Our current risk measurement stays still in the stage of interest-rate-sensitivity gap, which has big shortages.This article is on the measurement of interest rate risk in China’s commercial banks through the comparison of the various interest rate risk measurement methods, as well as empirical study on the inter-bank market with VaR method and feasibility analysis to explore the VaR application and prospects.The paper consists of six parts as follows:The first chapter named introduction part. This section first describes the background and significance of interest rate risk management, then introduces the literature of interest rate risk management and VaR method at Home and at Abroad to points out that the drawbacks of interest rate risk measurement in China. The structure of the article and innovation is added to the first part.In order to get a better comparison of various methods of risk measurement, the second part has a brief review on the interest rate risk and its causes. Interest rate risk management, including the gap analysis, duration analysis, simulation analysis and Value at Risk, is introduced in detail to compare of the advantages and disadvantages. Interest rate risk in Basel Capital Accord in recent years is inspected. Interest rate risk management and regulatory principles introduce the characteristics of a good interest rate risk measurement system to lay the foundation for the use of VaR. Theory can only play its guiding role combined with the reality, and the author found China’s interest rate risk management lack of consciousness of risk, measuring methods, management strategies and the advanced management model.The third part is about the VaR. This paper introduces the basic concepts of the VaR. The VaR calculation method consists of parameter method, the semi-parametric method and non-parametric method. The principle, applications, the advantages and limitations of each method are introduced in detail using comparative analysis to find the suitable application for China’s interest rate risk management. VaR are applied in the calculation of the value-at-risk, quota and risk capital and in performance measurement.The fourth part is the empirical section of this article, consisting of (a) empirical object selection-the overnight call rate of interbank lending market (b) inter-bank market interest rate volatility model ARMA-GARCH model(c) the empirical processed. The author found that (1) China’s interbank market fluctuation is similar to the stock market in volatility clustering, high kurtosis fat tail, and autocorrelation. When disturbance items obey the GED distribution is better than a normal distribution to describe the shape of the return series,(2) the leverage effect in the inter-bank market is different from the stock market in that when conducive to good news, the inter-bank market volatility increases, whereas return decrease, the inter-bank market fluctuations reduced,(3) when the inter-bank market volatility rises, the increased risk has no compensation. After comparing various VaR calculation method in back-testing, this conclusions are drawn that(a) AR (1)-GARCH-M-GED model of VaR have better performance in risk value calculation, while normal distribution assumption has poor coverage on extreme losses,(b)the maximum of mean and the standard deviation lie in GARCH model and the minimum is in normal distribution conditions adjustment, other non-parametric method needs of VaR perform ordinarily,(3) a better choice of the VaR model at this stage:asset prices follow a GARCH-M-GED-VaR model. What is new in the empirical study is that a thorough comparative analysis of various VaR calculation method as well as taking an out-sample test to meet the real situation of the interest rate risk measurement.The fifth part of this paper is the analysis of the application of VaR in interest rate risk management of commercial banks in China, which includes the necessity and feasibility analysis. The necessity introduces the defects of China’s interest rate risk management and the need of advanced management methods, and the feasibility is mainly about the application constraints of VaR model, about which the author proposed that (a) measure risk separately in different markets and accounts,(b) collecting valid data and trying to use high frequency data to overcome data defects,(c) take a variety of ways to simulate and predict fluctuations of interest rates.Part VI is a summary of the empirical analysis and application analysis. At last shortage of the research in this article is introduced as well as the outlook for interest rate risk measure of VaR.