Variable Deposit Betas, Convexity, and Changes in Bank Interest Rate Risk Exposure

45 Pages Posted: 12 Oct 2023 Last revised: 29 Nov 2023

See all articles by Mustafa Emin

Mustafa Emin

Tulane University

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Tao Li

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: August 22, 2023

Abstract

Whether maturity transformation exposes banks to interest rate risk depends in part on the effectiveness of bank deposits as a hedge against interest rate shocks. In this paper, we provide evidence that, despite an increase in the average maturity of bank assets, the duration of bank equity declined in the post-financial crisis era. We argue that one factor contributing to the decline was an increase in the average duration of deposits due to a decline in deposit betas when interest rates are low. The dynamics nature of the duration of deposits also explains why deposits provided a poor hedge against recent rate hikes. Overall we find that variable deposit betas combined with mortgage lending leads to a negative convex relationship between the value of bank equity and interest rates.

Keywords: Interest Rate Risk, Hedging, Deposit Betas

JEL Classification: G21, G38

Suggested Citation

Emin, Mustafa and James, Christopher M. and Li, Tao, Variable Deposit Betas, Convexity, and Changes in Bank Interest Rate Risk Exposure (August 22, 2023). Available at SSRN: https://ssrn.com/abstract=4598126 or http://dx.doi.org/10.2139/ssrn.4598126

Mustafa Emin

Tulane University ( email )

1440 Canal St.
NEW ORLEANS, LA 70112

Christopher M. James (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

Tao Li

University of Florida - Department of Finance, Insurance and Real Estate ( email )

Warrington College of Business
Gainesville, FL 32611
United States

HOME PAGE: http://warrington.ufl.edu/contact/profile.asp?WEBID=7628

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