The Use of Financial Derivatives and Risks of U.S. Bank Holding Companies (original) (raw)
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SSRN Electronic Journal, 2009
This study employs both contingent and non-contingent claim models to test for the existence of market discipline hypothesis for derivative contracts in U.S. banking industry. In addition to the Capital Asset Pricing Model (CAPM) measure of systematic risk and standard deviation of a bank's equity return, we apply Ronn-Verma option pricing model to assess whether market participants incorporate derivatives positions when they price banks' market risk. The benefit of using the contingent claim model is that the traditional linear models seem to be inadequate in estimating the non-linear relation between derivatives and bank risks. In order to capture the differences in marginal propensity to risk (MPR) across banks, we divide our bank holding company (BHC) sample into three groups: big, medium, and small. The conclusions are as follows. First, among the derivatives contracts, swaps are the major contracts that are incorporated in market risk valuation. They are viewed as risk reducing tools according to the three risk measures (Beta, equity return risk, and implied asset volatilities) for both big and medium BHCs. Second, futures, forwards, and options do not seem to have a major effect in valuation of bank market risk for all the three BHCs groups. However, we find a significant positive relationship between these three types of derivatives and market systematic risk (Beta). Third, generally, market participants view swaps positions as more of potential risk diversification tools. Fourth, small BHCs have the highest MPR while big banks have the lowest MPR. Finally, more capital and regulations on bank derivatives activities are required to minimize the impact of derivatives on banks' market risk.
The Economic Consequences of Banks’ Derivatives Use in Good Times and Bad Times
Journal of Financial Services Research, 2012
In a sample of 335 commercial banks, we do not detect a systematic effect on bank values from derivatives use in either the high growth period of 2003–2005 or the low growth period of 2007–2009. These findings apply to all types of derivatives including credit default swaps. Our results suggest that banks take a more balanced approach and restrict their derivative activities to providing derivative services for customers and risk management. We also find that the market disciplined banks significantly for taking TARP funds, indicating that receiving TARP funds was a signal that the banks were financially distressed. Lastly, we cannot discern valuation effects resulting from derivatives use even in large and poorly capitalized banks that are more likely to take risk-shifting opportunities. Collectively, we find no compelling evidence supporting the widespread allegation that derivatives use increased banks’ speculating behaviors and significantly contributed to the loss of value during the subprime mortgage crisis.
Evidence on the financial characteristics of banks that do and do not use derivatives
The Quarterly Review of Economics and Finance, 2000
While the use of derivatives by U.S. commercial banks has exploded in recent years, the growth has not been evenly distributed. At present, only about five percent of banks are involved in the market for derivatives. Although the concentration of derivatives activities in the largest banks is well known, we know less about other factors underlying a bank's decision to use derivatives. This article investigates the financial characteristics of banks that use derivatives and those that do not. We find that user banks, compared to nonusers, are associated with riskier capital structures (more notes and debentures and less equity capital), larger maturity mismatches between assets and liabilities, greater net loan charge-offs, and lower net interest margins. We also find that banks, especially smaller ones, benefit from being associated with bank-holding companies. Finally, our evidence does not support a regulatory hypothesis in which banks must have stronger capital positions to engage in derivative activities.
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In the financial markets, the financial institutions and banks use the financial derivatives for hedging against systemic risks, for speculation or/and arbitrage. This study aims to investigate mainly whether the use of financial derivatives makes banks reducing their systemic risks. Using the data of 19 commercial banks from GCC during the period from 2000 to 2013, the main results reveal that the use of financial derivatives decrease banks systemic risks, while the performance indexes effect is not obvious, it differs between a negative and a positive effect. However, banks use derivatives with the increase in off-balance sheet to hedge their risks. Finally, the rise of GDP does not give a safety feeling to managers of banks, so they tend to use derivatives to hedge, in addition, they use them also with the increase in inflation and unemployment rates for hedging purposes.
Derivatives and Interest Rate Risk Management by Commercial Banks
SSRN Electronic Journal, 2015
How do derivatives markets affect corporate decisions of financial intermediaries? I introduce interest rate swaps into the capital structure model of a bank. First, derivatives are a substitute to financial flexibility for risk management. Second, I show the existence of three distinct motives to engage in interest rate risk management. Together, they imply that both increases and decreases in the short rate can be optimally hedged. Third, the use of derivatives induces a "procyclical but asymmetric" lending policy. Derivatives users are better able to exploit transitory lending opportunities in good times, but do not cut lending proportionally more during either monetary contractions or real recessions. Finally, despite attractive insurance properties of derivative contracts, not all banks take derivative positions, as in the data. The model's predictions jointly match a number of yet unexplained stylized facts. New testable predictions are obtained.
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Journal of Futures Markets, 2007
This study examines derivatives use of foreign exchange, interest rate, and commodities risk by nonfinancial firms across multiple industries, using data from 1995 to 2001. This work considers the interaction of a firm's risk exposures, derivatives use, and real operations simultaneously, We thank Robert Webb (the editor) and anonyomous referee for their extremely helpful comments and suggestions, and Nosa Omoregie for his valuable research assistance. We also benefited from discussions with
British Journal of Economics, Management & Trade, 2017
There is a general perception that financial derivatives have significant impact on firm performance when they are used to hedge financial risks. The study attempted to examine the effect of the use of forwards, futures, options and swaps to hedge interest rate and foreign exchange rate risks of 5 financial and 5 nonfinancial firms selected from the UK FTSE 100 index, between the years 2005-2014, with the objectives of supporting or refuting extant literature on the benefits of hedging, testing the impact of hedging on return on assets and capital employed, as well as revealing which financial derivative assert the highest influence in the period. The panel least squares (PLS) regression analysis was used on a balanced panel dataset of 100 observations. The results revealed the following: (1) financial firms tend to hedge more of interest rate risks while nonfinancial firms hedge more of foreign exchange rate risks;(2) hedging interest rate risks by both groups with the use of a combination of forwards and futures derivatives was found to be positive and statistically significant with return on assets, hence increases firm performance, but directly has a