Managing Credit Risk with Credit Derivatives
AbstractGiven a commercial banking firm facing credit risk we develop a dynamic hedging model where the bank management can use credit derivatives. In a continuous-time framework optimal hedging strategies, deposit and loan decisions and consumption are studied. It is shown that the optimal hedge ratio consists of two elements: a speculative term which is controlled by the risk premium and the bank's risk aversion; and a pure hedge term which depends on the preferences of bank owners. Primarily the purpose of hedging is to stabilize the consumption path through a reduction in the variability of the dynamics of the wealth accumulation. Furthermore, we demonstrate that the asset/liability management is optimal if marginal cost equal marginal revenue for loans and deposits at each instant.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 17678.
Date of creation: 2005
Date of revision:
Banking firm; asset/liability management; credit risk; credit derivatives; dynamic hedging.;
Find related papers by JEL classification:
- E0 - Macroeconomics and Monetary Economics - - General
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Battermann, Harald L. & Braulke, Michael & Broll, Udo & Schimmelpfennig, Jorg, 2000. "The preferred hedge instrument," Economics Letters, Elsevier, vol. 66(1), pages 85-91, January.
- Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1992.
"Risk Management: Coordinating Corporate Investment and Financing Policies,"
NBER Working Papers
4084, National Bureau of Economic Research, Inc.
- Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
- Louberge, H. & Schlesinger, H., 2001.
"Coping with Credit Risk,"
36, Manitoba - Department of Economics.
- Briys, Eric & Solnik, Bruno, 1992. "Optimal currency hedge ratios and interest rate risk," Journal of International Money and Finance, Elsevier, vol. 11(5), pages 431-445, October.
- Briys, Eric & Crouhy, Michel & Schlesinger, Harris, 1990. " Optimal Hedging under Intertemporally Dependent Preferences," Journal of Finance, American Finance Association, vol. 45(4), pages 1315-24, September.
- Clark, Ephraim, 1997. "Valuing political risk," Journal of International Money and Finance, Elsevier, vol. 16(3), pages 477-490, June.
- Broll, Udo & Chow, Kong Wing & Wong, Kit Pong, 2001. "Hedging and Nonlinear Risk Exposure," Oxford Economic Papers, Oxford University Press, vol. 53(2), pages 281-96, April.
- Kit, Pong Wong, 1997. "On the determinants of bank interest margins under credit and interest rate risks," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 251-271, February.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).
If references are entirely missing, you can add them using this form.