Liquidity management and futures hedging under deposit insurance: An option-based analysis

Authors

  • Jyh-Horng Lin Graduate Institute of International Business, Tamkang University Tamsui Campus, Tamsui, Taipei, Taiwan,
  • Chuen-Ping Chang Graduate Institute of Management Sciences, Tamkang University, Taipei, and Department of Information Management, Diwan College of Management Tainan, Taiwan

DOI:

https://doi.org/10.2298/YJOR0402209L

Keywords:

liquidity, futures, deposit insurance, Black-Scholes valuation

Abstract

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.

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Published

2004-09-01

Issue

Vol. 14 No. 2 (2004)

Section

Research Articles

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Copyright (c) 2004 YUJOR

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