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Strengths And Weaknesses Of The Re-Pricing Model

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Koch and MacDonald, (2010), discussed the problem of finding an optimal Gap ratio, they stated that there is no specific optimal Gap ratio for all financial institutions and each company “must evaluate its overall risk and return profile and objectives to determine its optimal GAP”. A number of hedging studies suggest that a full hedge might not always be optimal for a financial intermediary (Grammatikos and Saunders, 1983; Junkus and Lee,
1985).
Wetmore and Brick, (1990), argue that zero Gap may not be optimal because of the basis risk, which implies that a financial institutions might be in better position with non-zero Gap. 2-8-1-3 Weaknesses of the Re-pricing Model
There are several weaknesses of the traditional re-pricing model; the following are the most important:
1- Re-pricing Gap model can help diminish the impact of market…show more content…
It basically predicts the maximum possible loss given a certain scenario by using probability distributions. This can be done in two ways, either by approximating the distribution by a parametric approximation such as a normal distribution or by considering the actual distribution. Usually, the confidence level used is 95 percent (Jorion, 2001). For example, suppose a daily VaR is stated as $100,000 for a 95 percent level of confidence. This means that there is only 5 percent chance that the loss the next day will be greater than $100,000. In other words, we expect this portfolio to lose more than $100,000 in one out of twenty days. Therefore, VaR is a measure of the worst expected loss that a portfolio may suffer over a period of time that has been specified by the user, under normal market conditions and a specified level of confidence (Chaudhury,
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