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Handbook of Asset and Liability Management: From models to optimal return strategies by Alexandre Adam

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14

Other Examples of Products Needing Behavioural Modelling

Tambour payé d'avance ne fait pas beaucoup de bruit.

14.1 PIPELINE RISK

Pipeline risk defines all the financial risk occurring from the moment a financial product is commercialized (and not of course sold) to the moment the product is booked and hedged.

For instance, loan offers may present a pipeline risk. Commercial entities may propose a fixed interest rate to the customer and a decision period (sometimes this is a legal decision period). Actually, there is a kind of option during this decision period: if the interest rates go down, the customer will have the opportunity to ask for another credit in another bank and if interest rates go up, he will accept the credit proposed at the beginning of the decision period (with a lower interest rate).

In terms of modelling, the A/L manager will have to model the ratio of loan offer acceptance as a function of the spread between the proposed interest rate and the level of market rates.

The uncertainty between a contract signature and the effective payment start date is another source of pipeline risk. For instance, when a customer needs a construction loan to build up a new home, it could take around two years to finish the construction. Of course, the customer does not get all the money at the loan signature: the bank gives him the money each time he has to pay for the construction:

  • At the loan signature, he will pay 30% to buy the building land for sale.
  • Periodically, ...

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