Prepayment risk poses a major challenge for banks managing fixed-rate mortgage portfolios, as early repayments can lead to unexpected changes in cash flows and interest rate exposures. Traditional hedging with vanilla interest rate swaps only captures part of this risk and often requires frequent rebalancing. Our presentation explores an alternative approach: using swaptions to hedge prepayment risk more efficiently. We introduce the intuition behind swaption-based hedging, explain how it can capture both delta and gamma exposure, and outline the setup of our analysis based on a Dutch mortgage portfolio and a three-factor interest rate model. We then discuss the insights gained from comparing vanilla swaps, European swaptions, and Bermudan swaptions under different prepayment scenarios. The presentation concludes with key takeaways on how incorporating swaptions can improve the stability and cost-effectiveness of mortgage risk management strategies in practice.

Lodewijk Verspeek is a quantitative risk management consultant at Zanders, where he focuses on Asset and Liability Management (ALM) and Interest Rate Risk in the Banking Book (IRRBB). He holds an MSc in Econometrics, specializing in Quantitative Finance, from Erasmus University Rotterdam. Lodewijk combines a strong quantitative background with hands-on experience in model development and model validation for financial institutions.