Bank risk, financial stress, and bank derivative use

Abstract

This paper distinguishes hedging from speculative derivative usage by U.S. bank holding companies (BHCs). This is accomplished by implementing a multi‐step procedure that relates the implied volatility from options on these banks, the broad components of the Cleveland Federal Reserve Bank Financial Stress Index, and off‐balance sheet derivatives. Our results indicate that BHCs with positive risk exposure to various financial stresses generally use interest rate, foreign exchange, equity, commodity, and credit derivatives to reduce their risk exposure to these financial stresses.