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UID:fae3bf05d0ac47836b342d79b93901bf
CATEGORIES:Seminars
CREATED:20250930T072008
SUMMARY:Konstantin Milbradt - Kellogg School of Management  Northwestern University
DESCRIPTION;ENCODING=QUOTED-PRINTABLE:\n\nInterest Rate Risk and Bank Hedging\n\n\nAbstract:\nHow do banks hedge 
 their business risk due to interest rate fluctuations, which naturally driv
 e both cash-flow risk and discount rate risk simultaneously? To answer this
  question we build a model where a bank’s profitability is determined by th
 e spreads on its loans and deposits, while its balance sheet growth is gove
 rned by equity and deposit flows, both of which depend on interest rates. F
 urthermore, the balance sheet growth is also affected by a maximum leverage
  ratio — defined using either accounting-based or market-based measures — i
 mposed by a regulator. Interest rate movement affects the tightness of this
  leverage constraint through its impact on profitability, on balance-sheet 
 growth, and even on the (endogenous) discounted value of bank equity. Ultim
 ately, a bank’s optimal hedging strategy stabilizes the marginal value of c
 ash for bank equity. On one hand, a bank would like to allocate an addition
 al dollar to the state with higher interest rate if that state has a greate
 r profitability and/or a higher balance sheet growth, which concerns the ca
 sh-flow effect. However, that state is also with a higher discount rate, an
 d the optimal hedging policy trades off these two discount and cash-flow ef
 fects. We show that a bank optimally hedges away the entire interest rate r
 isk — so that the resulting equity value is independent of interest rate — 
 when its deposit rate beta, loan rate beta, and deposit growth beta are zer
 o. Otherwise, the bank retains some optimal net exposure to interest rate r
 isk, aiming to stabilize its leverage ratio to avoid regulatory interventio
 n versus exploiting a shifting investment opportunity set driven by the int
 erest rate environment.\n
DTSTAMP:20260416T124840Z
DTSTART:20260309T163000Z
DTEND:20260309T180000Z
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