Banks, Price Risk, and Derivatives: Evidence and Implications for the Volcker Rule and Fair-Value Accounting

Abstract:     
In this study, I focus on banks' trading operations--namely, I examine banks' derivative use in hedging their price risk on trading assets. My two central findings are that banks use derivatives to hedge this risk and that derivatives are effective in hedging this risk. As an example, suppose that a bank holds in its trading book some US Treasuries and thus has price risk in interest rates: My first finding says that this bank uses interest-rate derivatives to hedge this risk; my second says that when interest rates change, this bank's derivatives dampen its net profit or loss on its Treasuries. These findings suggest that derivatives are a useful risk-management tool in mitigating the price risk of banks. These findings have implications for the Volcker Rule and for fair-value accounting.

Number of Pages in PDF File: 21

Keywords: banks, derivatives, price risk, hedging, trading operations, Volcker Rule, fair-value accounting

JEL Classification: G21, G28

working papers series