Guest Opinion: ALM Model Assumptions Need to Be Tested
An asset-liability management model makes a number of complex calculations for computing your credit union’s interest rate risk. The model’s results depend on the assumptions and whether the model was set up correctly to handle them. An ALM model summarizes results in a variety of standardized formats, many of which allow you to assess the interest rate risk exposure of your credit union. With all the complexities of an ALM model, you want to know that is it incorporating assumptions the way you intended. It’s important to look inside the black box to assess your model’s effectiveness. One way to do this is evaluate the model’s output for reasonableness. A good place to start would be the fair value matrix report.
The fair value matrix report lists detailed categories in the left column followed by columns showing the fair value computation for the flat rate scenario and each rate shock (up or down 100, 200 and 300 basis points). This report, while important, is difficult to analyze. For example, you want to know if the model is incorporating prepayment speeds as intended, and if so, what is the impact on fair value. Ideally, if you can get this report in a spreadsheet format, you can perform a few calculations that will make the results easier to analyze.