How to identify likely asset liability model errors.
Hi. I am Howard Lothrop host of Echo Partners TV. I'm here today to talk with you about errors and asset liability models. Not obvious errors.
The question you should be asking is, how would I know if I had errors in my asset liability modeling? It's a good question isn't it? And after all it's something you want to know.
Well here's my tip for you today. And this is specifically directed to smaller, less complex banks and by smaller what I'm talking about are asset size less than 1 billion and by less complex I mean banks that don't have a high degree of inverse floaters or other unusual instruments. You know, for the roughly 7000 banks that don't fit those two criteria this is a great tip for you.
What you should look at with your gap results, your earnings at risk results, and your EVE results and here's what you should see. You should see a consistency among these results. If your gap, particularly if it's a dynamic gap, shows you being asset sensitive you should see asset sensitivity exhibited in your simulation results as well.
Similarly, if you have asset sensitive earnings at risk, you should see an asset sensitive profile in your EVE or long-term earnings long-term interest rate risk. It's important that there be a consistency between these items because they are all drawing upon the same basic cash flow information, and they're all showing the same risk, albeit different snapshots in time.
So, one might be more or less asset sensitive than another, they should all be somewhat similar and consistent in their results. If you don't see this that's a key sign you might have an assumption that's perhaps incorrect or that there might be an error in the model itself.
Let me know if you have any questions or problems. I'll be glad to help. Thanks a lot and we'll see you on the next episode.