Optimal Futures Positions for Large Banking Firms
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- Author(s): GEORGE EMIR MORGAN, DILIP K. SHOME, STEPHEN D. SMITH
- Published: Apr 30, 2012
- Pages: 175-195
- DOI: 10.1111/j.1540-6261.1988.tb02596.x
In this paper, we extend earlier work on hedging models so that uncertainty about both deposit supply and loan demand is incorporated as well as random rates of return on loans and CD's. Our model suggests that the optimal forward position is the sum of three ratios that should be estimated simultaneously. Using bank‐specific data, the optimal hedge ratios are estimated in both the pre‐deregulation and deregulation subperiods. Our results show that previous studies of bank hedging with interest rate futures have greatly overstated (a) the volume of short futures positions that banks should take and (b) the degree of homogeneity of optimal hedge ratios across the banking system. Similarly, deregulation has not uniformly affected the interest rate risk borne by different institutions.