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Risk Management with Derivatives by Dealers and Market Quality in Government Bond Markets
Author(s) -
Naik Narayan Y.,
Yadav Pradeep K.
Publication year - 2003
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/1540-6261.00591
Subject(s) - futures contract , hedge , bond , business , core (optical fiber) , futures market , risk management , quality (philosophy) , spot market , market risk , monetary economics , economics , financial economics , finance , electricity , ecology , philosophy , materials science , epistemology , electrical engineering , composite material , biology , engineering
This paper investigates how bond dealers manage core business risk with interest rate futures and the extent to which market quality is affected by their selective risk taking. We observe that dealers use futures to take directional bets and hedge changes in their spot exposure. We find that, cross‐sectionally, a dealer with longer (shorter) risk exposure sells (buys) a larger amount of exposure the next day. However, this risk control takes place via the futures market and not the spot market. Finally, we find strong support for the price effects of capital constraints emphasized by Froot and Stein (1998).