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Underwater: Strategic Trading and Risk Management in Bank Securities Portfolios

Author

Listed:
  • Andreas Fuster

    (École Polytechnique Fédérale de Lausanne (EPFL); Swiss Finance Institute; Centre for Economic Policy Research (CEPR))

  • Teodora Paligorova

    (Board of Governors of the Federal Reserve System)

  • James I. Vickery

    (Federal Reserve Bank of Philadelphia)

Abstract

We use bond-level data to study how US banks managed securities portfolio risk during the 2022–23 interest rate surge. Rising yields lengthened the effective duration of callable bonds (especially agency MBS) and triggered deposit outflows. Exposed banks reduced both the volume and duration of bond purchases, but rarely sold existing bonds and did not expand qualified accounting hedges. Two frictions constrain adjustment: first, banks systematically avoid realizing losses, especially banks that exclude unrealized losses from regulatory capital. Second, hedging capacity is limited by fixed costs and callable bond complexity. Instead, banks reduced measured exposure by classifying high-risk bonds as held-to-maturity.

Suggested Citation

  • Andreas Fuster & Teodora Paligorova & James I. Vickery, 2026. "Underwater: Strategic Trading and Risk Management in Bank Securities Portfolios," Swiss Finance Institute Research Paper Series 26-06, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2606
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    Keywords

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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