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Managing Credit Risk With Credit Derivatives

Author

Listed:
  • UDO BROLL

    (Department of Economics, Technische Universität Dresden, Mommsenstrasse 13, D-01062, Dresden, Germany)

  • B. MICHAEL GILROY

    (Department of Economics, Universität Paderborn, Warburger Str. 100, D-33098, Paderborn, Germany)

  • ELMAR LUKAS

    (Department of Economics, Universität Paderborn, Warburger Str. 100, D-33098, Paderborn, Germany)

Abstract

Credit risk is one of the most important forms of risk faced by national and international banks as financial intermediaries. Managing this kind of risk through selecting and monitoring corporate and sovereign borrowers and through creating a diversified loan portfolio has always been one of the predominant challenges in bank management. The aim of our study is to examine how a risky loan portfolio affects optimal bank behavior in the loan and deposit markets, when derivatives to hedge credit risk are available. In a stochastic continuous-time framework a hedging model is developed where the bank management can use derivatives to hedge credit risk. Optimal loan, deposit and hedging strategies are then studied. It is shown that the magnitude and the direction of hedging are determined by the bank manager's preferences, the corresponding risk premium and the variance of the loan rate and its hedging instrument respectively.

Suggested Citation

  • Udo Broll & B. Michael Gilroy & Elmar Lukas, 2007. "Managing Credit Risk With Credit Derivatives," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(01), pages 1-13.
    • Handle: RePEc:wsi:afexxx:v:03:y:2007:i:01:n:s2010495207500042
    DOI: 10.1142/S2010495207500042
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    References listed on IDEAS

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    Cited by:

    1. Lakshmi, P., 2016. "Feasibility study of credit risk rating systems in banks," Asian Journal of Empirical Research, Asian Economic and Social Society, vol. 6(12), pages 294-306, December.

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    More about this item

    Keywords

    Banking firm; credit risk; credit derivatives; hedging; G11; G21; L10;
    All these keywords.

    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

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