How Do Banks Manage Interest Rate Risk: Hedge or Bet?

37 Pages Posted: 17 Jul 2008

See all articles by Luís Vasco Lourenço Pinheiro

Luís Vasco Lourenço Pinheiro

ISEGI NOVA

Miguel A. Ferreira

Nova School of Business and Economics; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Date Written: June 30, 2008

Abstract

Given the importance of interest rates risk in the banking industry, we study the success of banks interest rate hedging practices from 1980-2003. Using a sample of 371 banks, we investigate how well managers forecast interest rate movements by managing their own duration gaps. We also extend Flannery et al. (1984) factor model and recommend additional factors (slope, credit spread, foreign exchange and convexity) to explain bank stock returns. The major finding is that on average managers are not good forecasters. This result suggests that the majority of banks should focus more on the core business (loans and deposits) instead of viewing the asset and liability management as a profit center.

Keywords: Bank returns, Interest Risk Management, Duration Gap

JEL Classification: G21

Suggested Citation

Pinheiro, Luís Vasco Lourenço and Ferreira, Miguel Almeida, How Do Banks Manage Interest Rate Risk: Hedge or Bet? (June 30, 2008). 21st Australasian Finance and Banking Conference 2008 Paper. Available at SSRN: https://ssrn.com/abstract=1157672 or http://dx.doi.org/10.2139/ssrn.1157672

Luís Vasco Lourenço Pinheiro (Contact Author)

ISEGI NOVA ( email )

Campus de Campolide
Lisbon, 1070-312
Portugal

Miguel Almeida Ferreira

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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