Shifting the yield curve for fixed-income and derivatives portfolios

ArXiv ID: 2412.15986 “View on arXiv”

Authors: Unknown

Abstract

We use granular regulatory data on euro interest rate swap trades between January 2021 and June 2023 to assess whether derivative positions of Italian banks can offset losses on their debt securities holdings should interest rates rise unexpectedly. At the aggregate level of the banking system, we find that a 100-basis-point upward shift of the yield curve increases on average the value of swaps by 3.65% of Common Equity Tier 1 (CET1), compensating in part for the losses of 2.64% and 5.98% of CET1 recorded on debt securities valued at fair value and amortised cost. Variation exists across institutions, with some bank swap positions playing an offsetting role and some exacerbating bond market exposures to interest rate risk. Nevertheless, we conclude that, on aggregate, Italian banks use swaps as hedging instruments to reduce their interest rate exposures, which improves their ability to cope with the recent tightening of monetary policy. Finally, we draw on our swap pricing model to conduct an extensive data quality analysis of the transaction-level information available to authorities, and we show that the errors in fitting value changes over time are significantly lower compared to those in fitting the values themselves.

Keywords: Interest Rate Swaps, Bank Hedging, Yield Curve Analysis, Value at Risk (VaR), Data Quality Analysis

Complexity vs Empirical Score

  • Math Complexity: 5.0/10
  • Empirical Rigor: 8.0/10
  • Quadrant: Holy Grail
  • Why: The paper employs advanced financial mathematics for full revaluation of swap contracts and uses statistical models for data quality assessment, placing it in the medium-high complexity range. Empirical rigor is high due to the use of granular regulatory data (EMIR), extensive backtesting over a multi-year period, and rigorous data quality checks.
  flowchart TD
    A["Research Goal: Assess if Italian banks'<br>derivative positions offset debt security<br>losses during rate hikes"] --> B["Data & Methodology<br>Granular regulatory data<br>Jan 2021 - Jun 2023"]
    
    B --> C["Computational Process<br>100bps upward yield curve shift<br>Simulation applied to:<br>- Interest Rate Swaps<br>- Debt Securities (Fair Value & Amortised Cost)"]
    
    C --> D["Analysis & Pricing<br>Swap valuation modeling<br>Data quality analysis<br>Value change fitting"]
    
    D --> E["Key Findings / Outcomes"]
    
    E --> E1["Aggregate: Swaps offset bond losses<br>Swap gain: +3.65% CET1<br>Bond loss: -8.62% CET1 (combined)"]
    E --> E2["Institutional Variation<br>Swaps hedge for some,<br>exacerbate risk for others"]
    E --> E3["Data Quality<br>Value-change fitting errors<br>significantly lower than<br>value-fitting errors"]
    E --> E4["Conclusion<br>Swaps reduce interest rate exposure<br>Improves resilience to monetary tightening"]