Optimal Exercise of Brokered Callable Certificates of Deposit

Bank issued brokered certificates of deposit (CDs) trade in secondary markets, and some are callable. This paper studies the optimal exercise of brokered callable CDs. We compute the arbitrage-free value of brokered CDs based on U.S. Treasury rates, and determine the optimal exercise time for the callable CDs. Using these CD prices as a benchmark, we compute the spread between CD market prices and CD model values, which are non-zero, documenting their time series behavior. A regression analysis shows that these spreads reflect bank funding needs, CD contractual features, and market frictions. For callable CDs, we find that the market rarely overvalues the securities. We show that banks call the majority of callable CDs near the model's optimal boundary. However, banks with fewer issued CD's do not always follow the optimal exercise strategy, perhaps due to differential funding needs relative to banks with larger CD issuances.