Working Paper: CEPR ID: DP13787
Authors: Adriano A. Rampini; S. Viswanathan; Guillaume Vuillemey
Abstract: We study risk management in financial institutions using data on hedging of interest rate and foreign exchange risk. We find strong evidence that institutions with higher net worth hedge more, controlling for risk exposures, both across institutions and within institutions over time. For identification, we exploit net worth shocks resulting from loan losses due to drops in house prices. Institutions that sustain such shocks reduce hedging significantly relative to otherwise similar institutions. The reduction in hedging is differentially larger among institutions with high real estate exposure. The evidence is consistent with the theory that financial constraints impede both financing and hedging.
Keywords: risk management; financial institutions; interest rate risk; foreign exchange risk; financial constraints; derivatives
JEL Codes: G21; G32; D92; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Hedging Behavior (G41) | Risk Management Efforts (H12) |
| Net Worth (G19) | Hedging Behavior (G41) |
| Net Worth Decline (G59) | Hedging Reduction (G40) |
| Net Worth Shock (G59) | Hedging Behavior Change (G41) |
| High Real Estate Exposure (L85) | Hedging Reduction (G40) |