We study risk management in financial institutions using data on hedging of interest rate and foreign exchange risk. We find strong evidence that better capitalized institutions hedge more, controlling for risk exposures, both across institutions and within institutions over time. For identification, we exploit net worth shocks resulting from loan losses due to drops in house prices. Institutions that sustain such shocks reduce hedging significantly relative to otherwise similar institutions. The reduction in hedging is deferentially larger among institutions with high real estate exposure. The evidence is consistent with the theory that financial constraints impede both financing and hedging.
Adriano A. Rampini, S. Viswanathan, and Guillaume Vuillemey