Andreas Fuster - EPFL

"Underwater: Strategic Trading and Risk Management in Bank Securities Portfolios", w/ Teodora Paligorova & James I. Vickery

Abstract

We use bond-level data to study how US banks manage their securities portfolios, focusing on bank responses to the rapid shift in interest rates in 2022-23 and the role of financial and regulatory frictions in shaping bank behavior. Interest rate risk in bank portfolios increased sharply as rates rose, but with significant cross-bank heterogeneity depending on the ex ante share of bonds with embedded options. Exposed banks did not, however, offset the rise in risk either by selling long-duration bonds or hedging using "qualified" accounting hedges. We identify two frictions that may help account for this inertia. First, we show banks are highly averse to selling underwater bonds at a discount to book value--e.g., banks were 8-9 times more likely to trade bonds with unrealized gains than unrealized losses in 2022-23. This "strategic" trading is more pronounced for banks that do not recognize unrealized losses in regulatory capital and banks with low stock market valuations. Second, frictions in establishing qualified accounting hedges limited hedging activity depending on bond type and accounting classification. Banks did, however, reduce the sensitivity of regulatory capital to interest rates by classifying the riskiest bonds as held-to-maturity.

Additional information:

  • Speaker: Andreas Fuster
  • Time: Wednesday, 13.11.2024, 14:45 - 16:00
  • Location: Faculty Lounge, Room 0.036
  • Further links:
  • Organizer: Finance Group
  • Contact: