Interest Rate Risk Management in Uncertain Times

Submitted on 17th May 2019

We revisit the evidence on real effects of uncertainty shocks in the context of interest rate uncertainty, which can readily be hedged in the interest rate swap market. We document that adverse movements in interest rate uncertainty predict significant slowdowns in real activity, both at the aggregate and at the firm-level. To understand how firms cope with interest rate uncertainty, we develop a dynamic model of corporate investment, financing and risk management and test it using a rich dataset on corporate swap usage. Our results suggest that interest rate uncertainty depresses financially constrained firms’ investment in spite of hedging opportunities, as for these firms risk management by means of swaps is, effectively, risky.

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Lorenzo Bretscher, Lukas Schmid, Andrea Vedolin
Date Published