Interest Rate Risk Management of Bank Holding Companies: An Examination of Trade-Offs in the Use of Investment Securities and Interest Rate Swaps

Abstract

This paper examines the extent to which bank holding companies trade-off the use of investment securities and interest rate swaps when managing interest rate risk inherent in their core business. We find that both securities and swaps are used to hedge interest rate risk and that these two types of financial instruments are used as substitute hedging mechanisms. Our evidence suggests that the FASB's current proposal limiting hedge accounting treatment to derivative financial instruments may not reflect how banks manage interest rate risk. In addition, the discrepancy in accounting treatment may lead banks to prefer one of these two types of financial instruments.

JEL Classification: M41, G21, G28