Do You Know the Asset Liability Backtesting Secret?
There is a secret about backtesting in the asset liability modeling industry. Find out what it is.
Do you know the asset liability backtesting secret?
Hi I'm Howard Lothrop host of Echo Partners TV. I want to talk with you today about backtesting.
Now you know that backtesting is one of my favorite topics. Not only is it one of the most important aspects of your asset liability management program, it's also the source of the biggest industry secrets around.
I'm going to reveal that secret here today. And when you think about it will make a lot of sense to you.
Most asset liability consultants or model vendors are going to tell you that a high quality backtest result, one that is within 10% of the actual values experienced at the bank, is typically considered to be a good result. While it's true, it's not the whole story.
What we don't know when we look at our backtesting results necessarily is how they actually are going to change given movements in interest rates. That is, even the best backtest might give a misleading result if it's a period of relatively stable interest rates.
You don't really know the quality of your backtest until after you have had a somewhat sharper or measurable change in interest rates. And of course by then, it's too late to change moving forward. It's a little bit like closing the barn door after the horse has left.
So, look at your backtest results. Use it as you should to evaluate the quality of your assumptions and your asset liability model. But be aware that a big secret in asset liability management is you cannot really evaluate your backtesting results unless you have some recently significant interest rate risk movements.
Thanks so much and we'll see you on the next episode