Liquidity management and futures hedging under deposit insurance: An option-based analysis
DOI:
https://doi.org/10.2298/YJOR0402209LKeywords:
liquidity, futures, deposit insurance, Black-Scholes valuationAbstract
Theories on financial futures hedging are generally based on a portfolio-choice approach. This paper presents an alterative: a firm-theoretic model of bank behavior with financial futures under deposit insurance. Assuming that the bank is a certificate of deposit (CD) rate-setter and faces random CDs, expressions for the optimal futures hedge are derived under the option-based valuation. When the bank is in a bad state of the world, a decrease in the short position of the futures decreases the loan rate and increases the CD rate; an increase in the deposit insurance premium increases the loan rate and decreases the CD rate. We also show that the bank’s amount of futures increases with a lower expected futures interest rate.References
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