IDEAS home Printed from https://ideas.repec.org/a/eee/quaeco/v61y2016icp112-125.html
   My bibliography  Save this article

Hedging bank market risk with futures and forwards

Author

Listed:
  • Mun, Kyung-Chun

Abstract

This paper investigates the effectiveness for futures and forward hedging strategies that can be employed by large US banking firms with exposure to interest rate and foreign exchange risks. By measures of volatility reduction (VR) and value at risk (VaR), we find that while a single direct hedge performs no worse than a composite hedge in alleviating interest rate risk, it outperforms the composite hedge in reducing foreign exchange risk for banks that manage interest rate risk separately from foreign exchange risk. Also, the integrated hedge of both interest rate and foreign exchange risk with a single instrument of interest rate futures effectively outperforms the corresponding hedge with composite instruments in terms of reducing risks. The integrated hedge with currency forwards alone shows the poorest hedging effectiveness.

Suggested Citation

  • Mun, Kyung-Chun, 2016. "Hedging bank market risk with futures and forwards," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 112-125.
    • Handle: RePEc:eee:quaeco:v:61:y:2016:i:c:p:112-125
    DOI: 10.1016/j.qref.2015.11.004
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S106297691500112X
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.qref.2015.11.004?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Jongmoo Choi & Elyas Elyasiani, 1997. "Derivative Exposure and the Interest Rate and Exchange Rate Risks of U.S. Banks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 12(2), pages 267-286, October.
    2. Kathryn M. E. Dominguez & Linda L. Tesar, 2001. "A Reexamination of Exchange-Rate Exposure," American Economic Review, American Economic Association, vol. 91(2), pages 396-399, May.
    3. Memmel, Christoph, 2011. "Banks' exposure to interest rate risk, their earnings from term transformation, and the dynamics of the term structure," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 282-289, February.
    4. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer;Western Finance Association, vol. 26(2), pages 161-191, October.
    5. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October.
    6. Alessandri, Piergiorgio & Drehmann, Mathias, 2010. "An economic capital model integrating credit and interest rate risk in the banking book," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 730-742, April.
    7. Gordon M. Bodnar & M.H. Franco Wong, 2000. "Estimating Exchange Rate Exposures: Some "Weighty" Issues," NBER Working Papers 7497, National Bureau of Economic Research, Inc.
    8. Mun, Kyung-Chun & Emir Morgan, George, 2003. "Bank foreign exchange and interest rate risk management: simultaneous versus separate hedging strategies," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 277-297, July.
    9. Bauwens, Luc & Laurent, Sebastien, 2005. "A New Class of Multivariate Skew Densities, With Application to Generalized Autoregressive Conditional Heteroscedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 346-354, July.
    10. Purnanandam, Amiyatosh, 2007. "Interest rate derivatives at commercial banks: An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1769-1808, September.
    11. Donald Lien, 2008. "A note on estimating the benefit of a composite hedge," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(7), pages 711-716, July.
    12. Ken Cyree & Pinghsun Huang & James Lindley, 2012. "The Economic Consequences of Banks’ Derivatives Use in Good Times and Bad Times," Journal of Financial Services Research, Springer;Western Finance Association, vol. 41(3), pages 121-144, June.
    13. Abraham I. Brodt, 1988. "Optimal bank asset and liability management with financial futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 8(4), pages 457-481, August.
    14. Rosenberg, Joshua V. & Schuermann, Til, 2006. "A general approach to integrated risk management with skewed, fat-tailed risks," Journal of Financial Economics, Elsevier, vol. 79(3), pages 569-614, March.
    15. Michael G. Papaioannou, 2006. "Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms," South-Eastern Europe Journal of Economics, Association of Economic Universities of South and Eastern Europe and the Black Sea Region, vol. 4(2), pages 129-146.
    16. Donald Lien, 2010. "A note on the relationship between the variability of the hedge ratio and hedging performance," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 30(11), pages 1100-1104, November.
    17. English, William B. & Van den Heuvel, Skander J. & Zakrajšek, Egon, 2018. "Interest rate risk and bank equity valuations," Journal of Monetary Economics, Elsevier, vol. 98(C), pages 80-97.
    18. Drehmann, Mathias & Sorensen, Steffen & Stringa, Marco, 2010. "The integrated impact of credit and interest rate risk on banks: A dynamic framework and stress testing application," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 713-729, April.
    19. Koppenhaver, G D, 1985. "Bank Funding Risks, Risk Aversion, and the Choice of Futures Hedging Instrument," Journal of Finance, American Finance Association, vol. 40(1), pages 241-255, March.
    20. Anthony Santomero, 1997. "Commercial Bank Risk Management: An Analysis of the Process," Journal of Financial Services Research, Springer;Western Finance Association, vol. 12(2), pages 83-115, October.
    21. repec:bla:jfinan:v:53:y:1998:i:3:p:979-1013 is not listed on IDEAS
    22. Dominguez, Kathryn M.E. & Tesar, Linda L., 2006. "Exchange rate exposure," Journal of International Economics, Elsevier, vol. 68(1), pages 188-218, January.
    23. Cédric de Ville de Goyet & Geert Dhaene & Piet Sercu, 2008. "Testing the martingale hypothesis for futures prices: Implications for hedgers," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(11), pages 1040-1065, November.
    24. Dwight Grant & Mark Eaker, 1989. "Complex hedges: How well do they work?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 9(1), pages 15-27, February.
    25. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-350, July.
    26. Til Schuermann & Kevin J. Stiroh, 2006. "Visible and hidden risk factors for banks," Staff Reports 252, Federal Reserve Bank of New York.
    27. Bruce A. Benet, 1990. "Commodity futures cross hedging of foreign exchange exposure," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 10(3), pages 287-306, June.
    28. Grammatikos, Theoharry & Saunders, Anthony & Swary, Itzhak, 1986. "Returns and Risks of U.S. Bank Foreign Currency Activities," Journal of Finance, American Finance Association, vol. 41(3), pages 671-682, July.
    29. Sung Yong Park & Sang Young Jei, 2010. "Estimation and hedging effectiveness of time‐varying hedge ratio: Flexible bivariate garch approaches," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 30(1), pages 71-99, January.
    30. Bessembinder, Hendrik & Chan, Kalok, 1992. "Time-varying risk premia and forecastable returns in futures markets," Journal of Financial Economics, Elsevier, vol. 32(2), pages 169-193, October.
    31. G. D. Koppenhaver, 1990. "An empirical analysis of bank hedging in futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 10(1), pages 1-12, February.
    32. Sercu, Piet & Wu, Xueping, 2000. "Cross- and delta-hedges: Regression- versus price-based hedge ratios," Journal of Banking & Finance, Elsevier, vol. 24(5), pages 735-757, May.
    33. Andrew Kalotay & Leslie Abreo, 2001. "Testing Hedge Effectiveness For Fas 133: The Volatility Reduction Measure," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(4), pages 93-99, January.
    34. Anthony M. Santomero, 1997. "Commercial Bank Risk Management: An Analysis of the Process," Center for Financial Institutions Working Papers 95-11, Wharton School Center for Financial Institutions, University of Pennsylvania.
    35. Lee C. Adkins & David A. Carter & W. Gary Simpson, 2007. "Managerial Incentives And The Use Of Foreign‐Exchange Derivatives By Banks," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 30(3), pages 399-413, September.
    36. Philippe Artzner & Freddy Delbaen & Jean‐Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228, July.
    37. Brewer III, Elijah & Minton, Bernadette A. & Moser, James T., 2000. "Interest-rate derivatives and bank lending," Journal of Banking & Finance, Elsevier, vol. 24(3), pages 353-379, March.
    38. repec:bla:jfinan:v:43:y:1988:i:1:p:175-95 is not listed on IDEAS
    39. Kerkvliet, Joe & Moffett, Michael H., 1991. "The Hedging of an Uncertain Future Foreign Currency Cash Flow," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(4), pages 565-578, December.
    40. David Carter & Joseph Sinkey, 1998. "The Use of Interest Rate Derivatives by End-users: The Case of Large Community Banks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 14(1), pages 17-34, July.
    41. Allayannis, George & Ofek, Eli, 2001. "Exchange rate exposure, hedging, and the use of foreign currency derivatives," Journal of International Money and Finance, Elsevier, vol. 20(2), pages 273-296, April.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Cui, Yan & Feng, Yun, 2020. "Composite hedge and utility maximization for optimal futures hedging," International Review of Economics & Finance, Elsevier, vol. 68(C), pages 15-32.
    2. Anna Boldizsár & Zalán Kocsis & Zsuzsa Nagy-Kékesi & Gábor Sztanó, 2020. "FX Forward Market in Hungary: General Characteristics and Impact of the COVID Crisis," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 19(3), pages 5-51.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Mun, Kyung-Chun & Emir Morgan, George, 2003. "Bank foreign exchange and interest rate risk management: simultaneous versus separate hedging strategies," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 277-297, July.
    2. Barbara A. Bliss & Jeffrey A. Clark & R. Jared DeLisle, 2018. "Bank risk, financial stress, and bank derivative use," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(7), pages 804-821, July.
    3. Hao, Xiangchao & Sun, Qinru & Xie, Fang, 2022. "International evidence for the substitution effect of FX derivatives usage on bank capital buffer," Research in International Business and Finance, Elsevier, vol. 62(C).
    4. Deng, Saiying & Elyasiani, Elyas & Mao, Connie X., 2017. "Derivatives-hedging, risk allocation and the cost of debt: Evidence from bank holding companies," The Quarterly Review of Economics and Finance, Elsevier, vol. 65(C), pages 114-127.
    5. Ye, Min & Hutson, Elaine & Muckley, Cal, 2014. "Exchange rate regimes and foreign exchange exposure: The case of emerging market firms," Emerging Markets Review, Elsevier, vol. 21(C), pages 156-182.
    6. Horst Entorf & Gösta Jamin, 2007. "German Exchange Rate Exposure at DAX and Aggregate Levels, International Trade and the Role of Exchange Rate Adjustment Costs," German Economic Review, Verein für Socialpolitik, vol. 8(3), pages 344-374, August.
    7. Esposito, Lucia & Nobili, Andrea & Ropele, Tiziano, 2015. "The management of interest rate risk during the crisis: Evidence from Italian banks," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 486-504.
    8. Drobetz, Wolfgang & Erdmann, Thomas & Zimmermann, Heinz, 2007. "Predictability in the cross-section of European bank stock returns," Working papers 2007/21, Faculty of Business and Economics - University of Basel.
    9. Serkan Yilmaz Kandir & Ahmet Erismis, 2010. "Investigating Exchange Rate Exposure of Bank Shares: Empirical Evidence From ISE," Istanbul Stock Exchange Review, Research and Business Development Department, Borsa Istanbul, vol. 12(46), pages 49-83.
    10. Memmel, Christoph & Schertler, Andrea, 2011. "Banks' management of the net interest margin: Evidence from Germany," Discussion Paper Series 2: Banking and Financial Studies 2011,13, Deutsche Bundesbank.
    11. Wei, Lu & Li, Guowen & Li, Jianping & Zhu, Xiaoqian, 2019. "Bank risk aggregation with forward-looking textual risk disclosures," The North American Journal of Economics and Finance, Elsevier, vol. 50(C).
    12. Kretzschmar, Gavin & McNeil, Alexander J. & Kirchner, Axel, 2010. "Integrated models of capital adequacy - Why banks are undercapitalised," Journal of Banking & Finance, Elsevier, vol. 34(12), pages 2838-2850, December.
    13. Chaudron, Raymond F.D.D., 2018. "Bank's interest rate risk and profitability in a prolonged environment of low interest rates," Journal of Banking & Finance, Elsevier, vol. 89(C), pages 94-104.
    14. Christoph Memmel & Andrea Schertler, 2013. "Bank management of the net interest margin: new measures," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(3), pages 275-297, September.
    15. Uluc Aysun & Melanie Guldi, 2008. "Increasing Derivatives Market Activity in Emerging Markets and Exchange Rate Exposure," Working papers 2008-06, University of Connecticut, Department of Economics, revised Oct 2008.
    16. Parsley, David C. & Popper, Helen A., 2006. "Exchange rate pegs and foreign exchange exposure in East and South East Asia," Journal of International Money and Finance, Elsevier, vol. 25(6), pages 992-1009, October.
    17. Raymond Chaudron, 2016. "Bank profitability and risk taking in a prolonged environment of low interest rates: a study of interest rate risk in the banking book of Dutch banks," DNB Working Papers 526, Netherlands Central Bank, Research Department.
    18. Mayordomo, Sergio & Rodriguez-Moreno, Maria & Peña, Juan Ignacio, 2014. "Derivatives holdings and systemic risk in the U.S. banking sector," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 84-104.
    19. Yidi Sun & Bruce Morley, 2021. "The Dynamics of Foreign Exchange Derivative Use in China," JRFM, MDPI, vol. 14(7), pages 1-18, June.
    20. Bo Tang, 2015. "Exchange Rate Exposure of Chinese Firms at the Industry and Firm Level," Review of Development Economics, Wiley Blackwell, vol. 19(3), pages 592-607, August.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:quaeco:v:61:y:2016:i:c:p:112-125. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620167 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.