An interest rate risk management model for commercial banks

This paper develops a goal programming model to assist a commercial bank in managing its exposure to interest rate risk. The bank's objective is to immunize its equity position against innovations in interest rates while maximizing its market value. To accomplish this task, a duration gap framework is developed that does not require interest rate forecasts. As decision variables, the model includes assets, liabilities, and off-balance sheet derivative securities. The focus is on a protective-put strategy that uses options on interest rate futures, but to provide contrast, a short interest rate futures position is examined as well. Application of the model to an illustrative environment indicates that for larger interest rate changes the option strategy provides better protection against interest rate risk than the short futures position.