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Alligators in the swamp: the impact of derivatives on the financial performance of depository institutions

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  • Elijah Brewer
  • William E. Jackson
  • James T. Moser

Abstract

It has been argued that underpriced federal deposit insurance provides incentive for insured institutions to increase the value of shareholder equity by expanding into activities that shift risk onto the deposit insurer. Derivative instruments have been used by firms to change their risk exposure. Permitting firms with substantial moral hazard incentives to utilize interest-rate derivative instruments could lead to higher rather than lower exposure to risk. This article, using a sample of savings and loan associations (S&Ls), examines the proposition that involvement with interest-rate derivatives instruments increases depository institutions' risk. We find that there is a negative correlation between risk and derivatives usage. In addition, S&Ls that used derivatives experienced relatively greater growth in their fixed-rate mortgage portfolios. Copyright 1996 by Ohio State University Press.

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Bibliographic Info

Article provided by Federal Reserve Bank of Cleveland in its journal Proceedings.

Volume (Year): (1996)
Issue (Month): Aug ()
Pages: 482-501

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Handle: RePEc:fip:fedcpr:y:1996:i:aug:p:482-501

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Keywords: Derivative securities ; Savings and loan associations ; Econometric models;

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Cited by:
  1. Ruprecht, Benedikt & Entrop, Oliver & Kick, Thomas & Wilkens, Marco, 2013. "Market Timing, Maturity Mismatch, and Risk Management: Evidence from the Banking Industry," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79733, Verein für Socialpolitik / German Economic Association.
  2. J. David Cummins & Richard D. Phillips & Stephen D. Smith, 1997. "Derivatives and corporate risk management: participation and volume decisions in the insurance industry," Working Paper, Federal Reserve Bank of Atlanta 97-12, Federal Reserve Bank of Atlanta.
  3. Hogan, Arthur M. B. & Malmquist, David H., 1999. "Barriers to depository uses of derivatives: an empirical analysis," Journal of Multinational Financial Management, Elsevier, Elsevier, vol. 9(3-4), pages 419-440, November.
  4. Beverly J. Hirtle, 1996. "Derivatives, Portfolio Composition and Bank Holding Company Interest Rate Risk Exposure," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 96-43, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. J. Cummins & Georges Dionne & Robert Gagné & A. Nouira, 2009. "Efficiency of insurance firms with endogenous risk management and financial intermediation activities," Journal of Productivity Analysis, Springer, Springer, vol. 32(2), pages 145-159, October.
  6. Antonio Roma, 2006. "Common factors and balance sheet structure of major European banks," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, Banca Nazionale del Lavoro, vol. 59(237), pages 123-170.
  7. Cooper, Michael J. & Jackson, William III & Patterson, Gary A., 2003. "Evidence of predictability in the cross-section of bank stock returns," Journal of Banking & Finance, Elsevier, Elsevier, vol. 27(5), pages 817-850, May.
  8. Castrén, Olli & Fitzpatrick, Trevor & Sydow, Matthias, 2006. "What drives EU banks’ stock returns? Bank-level evidence using the dynamic dividend-discount model," Working Paper Series, European Central Bank 0677, European Central Bank.
  9. Jian Yang & David J. Leatham & Spencer A. Case, 2000. "The wealth effect of swap usage in the food processing industry," Agribusiness, John Wiley & Sons, Ltd., vol. 16(3), pages 367-379.
  10. Antonio Roma, 2006. "Common factors and balance sheet structure of major European banks," BNL Quarterly Review, Banca Nazionale del Lavoro, Banca Nazionale del Lavoro, vol. 59(237), pages 123-170.
  11. Chaudhry, Mukesh K. & Christie-David, Rohan & Koch, Timothy W. & Reichert, Alan K., 2000. "The risk of foreign currency contingent claims at US commercial banks," Journal of Banking & Finance, Elsevier, Elsevier, vol. 24(9), pages 1399-1417, September.

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