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LASH risk and Interest Rates

Author

Listed:
  • Laura Alfaro

    (Harvard Business School)

  • Saleem Bahaj

    (University College London
    Bank of England)

  • Robert Czech

    (Bank of England)

  • Jonathon Hazell

    (London School of Economics)

  • Ioana Neamtu

    (Bank of England)

Abstract

This paper studies a form of liquidity risk that we call Liquidity After Solvency Hedging or “LASH” risk. Financial institutions take LASH risk when they hedge against solvency risk, using strategies that require liquidity when the solvency of the institution improves. We focus on LASH risk relating to interest rate movements. Our framework implies that institutions with longer-duration liabilities than assets — e.g. pension funds and insurers—take more LASH risk as interest rates fall. Using UK regulatory data from 2019-22 on the universe of sterling repo and swap transactions, we measure, in real time and at the institution level, LASH risk for the non-bank sector. We find that at the peak level of LASH risk, a 100bps increase in interest rates would have led to liquidity needs close to the cash holdings of the pension fund and insurance sector. Using a cross-sectional identification strategy, we find that low interest rates caused increases in LASH risk. We then find that the pre-crisis LASH risk of non-banks predicts their bond sales during the 2022 UK bond market crisis, contributing to the yield spike in the market.

Suggested Citation

  • Laura Alfaro & Saleem Bahaj & Robert Czech & Jonathon Hazell & Ioana Neamtu, 2024. "LASH risk and Interest Rates," Discussion Papers 2443, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2443
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    References listed on IDEAS

    as
    1. Gabriel Jiménez & Steven Ongena & José‐Luis Peydró & Jesús Saurina, 2014. "Hazardous Times for Monetary Policy: What Do Twenty‐Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk‐Taking?," Econometrica, Econometric Society, vol. 82(2), pages 463-505, March.
    2. Ms. Ruo Chen & Esti Kemp, 2023. "Putting Out the NBFIRE: Lessons from the UK's Liability-Driven Investment (LDI) Crisis," IMF Working Papers 2023/210, International Monetary Fund.
    3. Konradt, Maximilian, 2023. "Do pension funds reach for yield? Evidence from a new database," MPRA Paper 116209, University Library of Munich, Germany.
    4. Yiming Ma & Kairong Xiao & Yao Zeng, 2022. "Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 35(10), pages 4674-4711.
    5. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 67(1), pages 91-116.
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    More about this item

    Keywords

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F30 - International Economics - - International Finance - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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