Creating contingent liabilities for depository institutions

Abstract

Financial intermediaries have been very creative in engineering contingent liabilities such as certificates of deposits (CDs) linked to a stock market index, commodity price, or other economic variables. generic model for pricing such creations, and give specific examples for pricing some existing contingent liabilities. We consider some potential new creations, and discuss implications for regulators. Finally, we propose to develop parameters for expert systems to provide assistance in managing a portfolio of contingent liabilities, including dynamic hedging strategies; which take into account the correlation between the interest on the contingent liabilities and the earnings from the issuer's portfolio of loans and other assets, as well as the transactions costs in portfolio revisions.