IDEAS home Printed from https://ideas.repec.org/a/eee/ecmode/v31y2013icp659-663.html
   My bibliography  Save this article

Fixed versus variable rate loans under state-dependent preferences

Author

Listed:
  • Wong, Kit Pong

Abstract

This paper examines the optimal mix of fixed and variable rate loans of a competitive bank facing uncertain funding costs. The bank's preferences are state-dependent in that the utility function depends on a state variable. We show that the optimal amount of loans extended by the bank depends neither on the state-dependent preferences of the bank, nor on the joint distribution of the marginal cost of funds and the state variable. The bank, however, optimally lends less should it be forced to assume all interest rate risk by exclusively extending fixed rate loans. We show further that a non-positive spread between fixed and variable rate loans is no longer a necessary and sufficient condition for the bank to refrain from extending fixed rate loans should the marginal cost of funds be correlated with the state variable in the sense of expectation dependence. State-dependent preferences as such play a pivotal role in determining the bank's optimal choice between fixed and variable rate loans.

Suggested Citation

  • Wong, Kit Pong, 2013. "Fixed versus variable rate loans under state-dependent preferences," Economic Modelling, Elsevier, vol. 31(C), pages 659-663.
  • Handle: RePEc:eee:ecmode:v:31:y:2013:i:c:p:659-663
    DOI: 10.1016/j.econmod.2013.01.006
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0264999313000084
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
    2. Briys, Eric & Crouhy, Michel & Schlesinger, Harris, 1993. "Optimal hedging in a futures market with background noise and basis risk," European Economic Review, Elsevier, vol. 37(5), pages 949-960, June.
    3. Udo Broll & Kit Wong, 2010. "Banking firm and hedging over the business cycle," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 9(1), pages 29-33, April.
    4. Cuadras, C. M., 2002. "On the Covariance between Functions," Journal of Multivariate Analysis, Elsevier, vol. 81(1), pages 19-27, April.
    5. Adam-Muller, Axel F. A., 2000. "Hedging price risk when real wealth matters," Journal of International Money and Finance, Elsevier, vol. 19(4), pages 549-560, August.
    6. Wong, Kit Pong, 2011. "Regret theory and the banking firm: The optimal bank interest margin," Economic Modelling, Elsevier, vol. 28(6), pages 2483-2487.
    7. Soon Koo Hong & Keun Ock Lew & Richard MacMinn & Patrick Brockett, 2011. "Mossin's Theorem Given Random Initial Wealth," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 78(2), pages 309-324, June.
    8. Kit Pong Wong, 2012. "Production and hedging under state‐dependent preferences," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(10), pages 945-963, October.
    9. Santomero, Anthony M, 1983. " Fixed versus Variable Rate Loans," Journal of Finance, American Finance Association, vol. 38(5), pages 1363-1380, December.
    10. Broll, Udo & Eckwert, Bernhard, 1998. "Export and Hedging Decision with State-Dependent Utility," International Review of Economics & Finance, Elsevier, vol. 7(3), pages 247-253.
    11. Chang Eric C. & Moon-Whoan Rhee & Kit Pong Wong, 1995. "A note on the spread between the rates of fixed and variable rate loans," Journal of Banking & Finance, Elsevier, vol. 19(8), pages 1479-1487, November.
    12. Louis Eeckhoudt & Béatrice Rey & Harris Schlesinger, 2007. "A Good Sign for Multivariate Risk Taking," Management Science, INFORMS, vol. 53(1), pages 117-124, January.
    13. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July.
    14. Lence, Sergio H., 1995. "On the optimal hedge under unbiased futures prices," Economics Letters, Elsevier, vol. 47(3-4), pages 385-388, March.
    15. Li, Jingyuan, 2011. "The demand for a risky asset in the presence of a background risk," Journal of Economic Theory, Elsevier, vol. 146(1), pages 372-391, January.
    16. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    17. Donald Lien, 2004. "State-Dependent Preferences And Futures Hedging: The Effects Of Basis Risk," Pacific Economic Review, Wiley Blackwell, vol. 9(2), pages 143-149, June.
    18. 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 1629-1658, December.
    19. Broll, Udo & Wong, Kit Pong, 2002. "Optimal full-hedging under state-dependent preferences," The Quarterly Review of Economics and Finance, Elsevier, vol. 42(5), pages 937-943.
    20. Broll, Udo & Eckwert, Bernhard & Eickhoff, Andreas, 2012. "Financial intermediation and endogenous risk in the banking sector," Economic Modelling, Elsevier, vol. 29(5), pages 1618-1622.
    21. Tsai, Jeng-Yan, 2012. "Risk and regret aversions on optimal bank interest margin under capital regulation," Economic Modelling, Elsevier, vol. 29(6), pages 2190-2197.
    22. Karni, Edi & Schmeidler, David & Vind, Karl, 1983. "On State Dependent Preferences and Subjective Probabilities," Econometrica, Econometric Society, vol. 51(4), pages 1021-1031, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Wong, Kit Pong, 2014. "Fixed versus variable rate loans under regret aversion," Economic Modelling, Elsevier, vol. 42(C), pages 140-145.
    2. Guo, Xu & Li, Jingyuan, 2016. "Confidence band for expectation dependence with applications," Insurance: Mathematics and Economics, Elsevier, vol. 68(C), pages 141-149.

    More about this item

    Keywords

    Fixed rate loans; State-dependent preferences; Variable rate loans;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:ecmode:v:31:y:2013:i:c:p:659-663. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/30411 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.