The model, by using a contingent claim approach, determines the fair value of the banks’ liabilities accounting for the protection and the surrender possibility. Furthermore, it determines the interest rate risk in combination with the stochastic optimization to obtain the implications for immunization.

The asset liability management has its origin in the duration analysis proposed by Macaulay (1938) and Redington (1952). The frontier of asset liability management is based on stochastic optimization that involves an asset allocation approach by considering the liabilities side as well. The basic idea is to maximize the surplus between assets and liabilities in a stochastic environment, usually subject to some constraints. There are two approaches to the solution of the problem: one is the mathematical solution and the other is the simulated solution. Due to the complexity of the problem, simulated solution is mostly used. Indeed, the mathematical solution is not unique and does not permit a clear vision of the problem by analyzing every possible scenario. The duration analysis of banks’ liabilities is still an open question due to the fact that the deposits do not have a time to maturity known ex ante, because it is possible to know it just ex post. Indeed, the duration of deposits is not only a matter of maturity, but is also affected by the contractual geometry and the possibility of surrender, as shown in the next section. In fact, by using a contingent claim approach, it is possible to get the duration of banks’ liabilities in a closed form. It is possible to immunize the equity value of a bank by equalling the duration of bonds portfolio in the assets to the duration of banks’ liabilities, as suggested by Macaulay (1938) and Redington (1952).

Bank Management Journal, Indian Banks, Asset Liability Management, Data Filtering, Least Absolute Deviation, Decision-Making Group, Commercial Banks, Ordinary Least Square, Banking Industry, Kenyan Banks, Least Squares Regression, Mutual Fund Industry, Linear Programming, Financial Markets, Capital Required Adequacy Ratio, Public Sector Banks.