The Economic Consequences of Banks' Derivatives Use in Good Times and Bad Times

Document Type

Article

Publication Date

6-1-2012

School

Finance

Abstract

In a sample of 335 commercial banks, we do not detect a systematic effect on bank values from derivatives use in either the high growth period of 2003-2005 or the low growth period of 2007-2009. These findings apply to all types of derivatives including credit default swaps. Our results suggest that banks take a more balanced approach and restrict their derivative activities to providing derivative services for customers and risk management. We also find that the market disciplined banks significantly for taking TARP funds, indicating that receiving TARP funds was a signal that the banks were financially distressed. Lastly, we cannot discern valuation effects resulting from derivatives use even in large and poorly capitalized banks that are more likely to take risk-shifting opportunities. Collectively, we find no compelling evidence supporting the widespread allegation that derivatives use increased banks' speculating behaviors and significantly contributed to the loss of value during the subprime mortgage crisis.

Publication Title

Journal of Financial Services Research

Volume

41

Issue

3

First Page

121

Last Page

144

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