Banking firm and hedging over the business cycle

Broll, Udo; Kit, Pong Wong

http://hdl.handle.net/10400.5/15608

Use this identifier to reference this record.

Name:	Description:	Size:	Format:
pej-9-1-2010-3.pdf		193.9 KB	Adobe PDF	Download

Send Feedback

Authors

Broll, Udo

Kit, Pong Wong

Abstract(s)

This paper examines the behavior of a banking firm under risk. The banking firm can hedge its risk exposure by trading futures contracts. The banking firm is risk averse and possesses a utility function defined over its end-of-period income and a state variable that denotes the business cycle of the economy. We show that the banking firm optimally opts for an overhedge or an under-hedge, depending on whether the returns on the futures contracts are negatively or positively correlated with the business cycle of the economy, respectively. Thus, the business cycle of the economy is an important determinant in shaping the banking firm’s optimal hedging strategy.