Financial Derivatives and Bank Risk: Evidence from Eighteen Developed Markets

Accounting and Business Research, Forthcoming

43 Pages Posted: 21 May 2019

See all articles by Xing Huan

Xing Huan

University of Warwick - Accounting Group

Antonio Parbonetti

University of Padua

Date Written: May 10, 2019

Abstract

We examine the relationship between equity risk and the use of financial derivatives with a sample of 555 banks from eighteen developed markets from 2006 to 2015. Our main findings suggest that banks’ use of financial derivatives increased their risk. This increase in risk can be driven by banks’ use of derivatives for speculative purposes, by suboptimal hedging to obtain hedge accounting status, or from accounting mismatches that generate volatility in earnings. We also show that this relationship is nonlinear. Too-Big-To-Fail banks and those that employ a traditional retail banking business model are subject to lower idiosyncratic risk. We address endogeneity concerns using instrumental variables capturing the use of derivatives with portfolio ranking. Overall, our study contributes to understanding the impact of derivatives use on bank risk and the risk consequences of a bank’s business model choice.

Keywords: Derivative Accounting, Fair Value, Financial Derivatives, Risk Management

JEL Classification: G21, M41, G23, G32

Suggested Citation

Huan, Xing and Parbonetti, Antonio, Financial Derivatives and Bank Risk: Evidence from Eighteen Developed Markets (May 10, 2019). Accounting and Business Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3379646

Xing Huan (Contact Author)

University of Warwick - Accounting Group ( email )

Warwick Business School
Coventry CV4 7AL
United Kingdom

Antonio Parbonetti

University of Padua ( email )

Via del Santo 33
Padova, 35123
Italy
+39 049 8274261 (Phone)

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