Valuing Sticky Deposits

We develop a formal fixed-income framework to value sticky deposits. This framework provides closed-form expressions for deposit values and allows us to study the impact of stickiness on deposit interest-rate and runoff risks. The duration of a bank deposit can be either positive or negative, which has important implications for hedging the interest-rate risk of bank balance sheets. Banks that maximize deposit value by following optimal deposit beta strategies may significantly increase their interest-rate and deposit runoff risks. We test the empirical implications of the valuation model using market deposit premia observed in bank merger/acquisition transactions. The results provide strong empirical support for the model’s predictions.