Monetary Shocks and Bank Balance Sheets

Sebastian Di Tella and Pablo Kurlat ()
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Sebastian Di Tella: Stanford GSB

No 650, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: We propose a model to explain why banks' balances sheets are exposed to interest rate risk despite the existence of markets where that risk can be hedged. A rise in nominal interest rates raises the opportunity cost of holding currency; since bank liabilities are close substitutes of currency, demand for bank liabilities rises and banks earn higher spreads. If risk aversion is higher than 1, the optimal dynamic hedging strategy is to sustain capital losses when nominal interest rates rise and, conversely, capital gains when they fall. A traditional bank balance sheet with long duration nominal assets achieves that.

Date: 2015
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:650

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