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Derivatives-hedging, risk allocation and the cost of debt: Evidence from bank holding companies

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  • Deng, Saiying
  • Elyasiani, Elyas
  • Mao, Connie X.

Abstract

We investigate the association between derivatives-hedging and the cost of debt in publicly-traded bank holding companies (BHCs) and test the risk-allocation effect of derivatives-hedging using the 2007–2009 financial crisis as a quasi-experiment. Consistent with Froot and Stein (1998) and Schrand and Unal (1998), we find evidence supporting the risk allocation hypothesis in BHCs. Banks reduce their exposure to tradable risk (e.g., interest rate and exchange rate risks) via derivatives-hedging and simultaneously extend more loans and take greater credit risk in lending (their main area of expertise) in order to earn higher economic rents. The risk allocation strategy is associated with an increase in overall bank risk, measured by the cost of debt, during the non-crisis periods but its dynamics breaks down during the financial crisis of 2007–2009, resulting in a negative relationship between derivatives-hedging and the cost of debt.

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  • Deng, Saiying & Elyasiani, Elyas & Mao, Connie X., 2017. "Derivatives-hedging, risk allocation and the cost of debt: Evidence from bank holding companies," The Quarterly Review of Economics and Finance, Elsevier, vol. 65(C), pages 114-127.
    • Handle: RePEc:eee:quaeco:v:65:y:2017:i:c:p:114-127
    DOI: 10.1016/j.qref.2016.06.004
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    Cited by:

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    3. Caterina Di Tommaso, 2022. "Securitization and CDS in U.S. bank lending," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(1), pages 1120-1133, January.
    4. Tran, Dung Viet & Hassan, M. Kabir & AlTalafha, Sarah H. & Turunen-Red, Arja, 2021. "Policy uncertainty, the use of derivatives: Evidence from U.S. bank holdingcompanies (BHCs)," Research in International Business and Finance, Elsevier, vol. 58(C).
    5. Elshandidy, Tamer & Acheampong, Albert, 2021. "Does hedge disclosure influence cost of capital for European banks?," International Review of Financial Analysis, Elsevier, vol. 78(C).
    6. Hasan Dinçer & Serhat Yüksel & Fatih Pınarbaşı & Mehmet Ali Alhan, 2020. "Risky Financial Assets in Financial Integration and the Impacts of Derivatives on Banking Returns," World Scientific Book Chapters, in: Stéphane Goutte & Khaled Guesmi (ed.), Risk Factors and Contagion in Commodity Markets and Stocks Markets, chapter 6, pages 133-159, World Scientific Publishing Co. Pte. Ltd..
    7. Barbara A. Bliss & Jeffrey A. Clark & R. Jared DeLisle, 2018. "Bank risk, financial stress, and bank derivative use," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(7), pages 804-821, July.
    8. Trinh, Vu Quang & Aljughaiman, Abdullah A. & Cao, Ngan Duong, 2020. "Fetching better deals from creditors: Board busyness, agency relationships and the bank cost of debt," International Review of Financial Analysis, Elsevier, vol. 69(C).
    9. Hao, Xiangchao & Sun, Qinru & Xie, Fang, 2022. "International evidence for the substitution effect of FX derivatives usage on bank capital buffer," Research in International Business and Finance, Elsevier, vol. 62(C).

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    More about this item

    Keywords

    Bank holding company; Derivatives; Hedging; Cost of debt; Bank lending; Risk-allocation;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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