DP13787 Risk Management in Financial Institutions

Author(s): Adriano A. Rampini, S. Viswanathan, Guillaume Vuillemey
Publication Date: June 2019
Keyword(s): Derivatives, Financial constraints, financial institutions, Foreign exchange risk, interest rate risk, Risk management
JEL(s): D92, E44, G21, G32
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13787

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.