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Please use this identifier to cite or link to this item: http://hdl.handle.net/2108/157

Title: Managing the risk of loans with basis risk sell, hedge or do nothing
Authors: Wall, Larry D.
Shrikhande, Milind M.
Issue Date: Mar-2001
Publisher: CEIS
Series/Report no.: Quaderni CEIS; 143
Abstract: Individual loans contain a bundle of risks including credit risk, and interest rate risk. This paper focuses on the general issue of bank’s management of these various risks in a model with costly loan monitoring and convex taxes. The results suggest that if the hedge is not subject to basis risk then hedging dominates a strategy of do nothing. Whether hedging dominates loan sales depends on whether it induces reduced monitoring, the net benefit of monitoring and the reduced tax burden of eliminating all risk via selling. If the hedge is subject to basis risk then a do nothing strategy may dominate the hedging and loan sales strategy for risk neutral banks. A number of empirical implications follow from the analytical and numerical results in the paper
URI: http://hdl.handle.net/2108/157
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