This paper provides a review of developments in the area of risk management at both the firm level and the macro-economy. We review rationales regarding why firms choose to manage risk, as well as new developments in measuring and managing risk in a dynamic setting. We also consider current risk sharing arrangements in light of the theory regarding optimal risk sharing. The paper concludes with some suggestions for additional research that emphasizes the importance of incorporating market incompleteness in an equilibrium setting. We also discuss the role of incompleteness at the macro-level and speculate on how derivatives markets may influence macro-economic stabilization policy.

The authors investigate the structure of preferences and uncertainty that guarantees that prices are fully revealing even though asset markets are incomplete and there are more sources of uncertainty than assets in the economy. A sufficient condition for fully revealing prices is that investors have preferences of the (possibly state-dependent) linear-risk-tolerance class. Finally, the authors discuss how their result allows one to extend certain existing literature on demand aggregation, welfare analysis, and the pricing of contingent claims to the case in which markets are incomplete and investors have asymmetric private information.

This paper considers the maturity intermediation and intertemporal lending decisions of risk-averse financial intermediaries. In particular, the maturity mismatch problem and the fixed-versus-variable-rate lending decision are modeled when the major source of risk involves uncertain future interest rates. The results imply that the strategy of matching the maturity of assets and liabilities is not generally optimal or even minimum risk. This is due primarily to the “built-in” hedge that the intermediary has as a result of rolling over short-term loans while continuing to finance long-term loans. Intertemporal dependencies between loan demand and costs (or both) also have an effect on the optimal degree of maturity mismatching and provide one rationale for making loans at rates below current marginal cost.

This paper considers the maturity intermediation and intertemporal lending decisions of risk‐averse financial intermediaries. In particular, the maturity mismatch problem and the fixed‐versus‐variable‐rate lending decision are modeled when the major source of risk involves uncertain future interest rates. The results imply that the strategy of matching the maturity of assets and liabilities is not generally optimal or even minimum risk. This is due primarily to the “built‐in” hedge that the intermediary has as a result of rolling over short‐term loans while continuing to finance long‐term loans. Intertemporal dependencies between loan demand and costs (or both) also have an effect on the optimal degree of maturity mismatching and provide one rationale for making loans at rates below current marginal cost.

In this paper we theoretically and empirically examine the interaction between hedging, financing, and investment decisions. A simple equilibrium model with costly financial distress suggests that as firms become more efficient at risky investments vis a vis low risk investments, they will borrow less, invest more in risky assets, and hedge more. The model also predicts a positive relationship between hedging and leverage – a result consistent with debt capacity arguments. We test the model empirically using a simultaneous equations framework to investigate the determinants of firm-level hedging, financing and investing decisions. The results strongly support the hypothesis that the hedging, financing and investment decisions are jointly determined. In addition, we find strong support for the central hypothesis that firms more efficient investing in risky technologies more aggressively hedge and use less debt financing in order to maximize their comparative advantage.

The minimum cost output configuration for a firm may change as the result of a variety of factors, including changes in market structure. In this paper we test this structural change hypothesis with savings and loan data. We find support for the hypothesis that separable, constant returns to scale production functions characterize the average savings and loan in our sample in 1983. This is in contrast to the cost complementarities found in 1978. We argue that this result may be the result of regulatory changes that allowed savings and loans to alter their production mix to fully capture the benefits of joint production.

The minimum cost output configuration for a firm may change as the result of a variety of factors, including changes in market structure. In this paper we test this structural change hypothesis with savings and loan data. We find support for the hypothesis that separable, constant returns to scale production functions characterize the average savings and loan in our sample in 1983. This is in contrast to the cost complementarities found in 1978. We argue that this result may be the result of regulatory changes that allowed savings and loans to alter their production mix to fully capture the benefits of joint production.

In this paper, we extend earlier work on hedging models so that uncertainty about both deposit supply and loan demand is incorporated as well as random rates of return on loans and CD's. Our model suggests that the optimal forward position is the sum of three ratios that should be estimated simultaneously. Using bank-specific data, the optimal hedge ratios are estimated in both the pre-deregulation and deregulation subperiods. Our results show that previous studies of bank hedging with interest rate futures have greatly overstated (a) the volume of short futures positions that banks should take and (b) the degree of homogeneity of optimal hedge ratios across the banking system. Similarly, deregulation has not uniformly affected the interest rate risk borne by different institutions.

In this paper, we extend earlier work on hedging models so that uncertainty about both deposit supply and loan demand is incorporated as well as random rates of return on loans and CD's. Our model suggests that the optimal forward position is the sum of three ratios that should be estimated simultaneously. Using bank‐specific data, the optimal hedge ratios are estimated in both the pre‐deregulation and deregulation subperiods. Our results show that previous studies of bank hedging with interest rate futures have greatly overstated (a) the volume of short futures positions that banks should take and (b) the degree of homogeneity of optimal hedge ratios across the banking system. Similarly, deregulation has not uniformly affected the interest rate risk borne by different institutions.