BANKING RISKS AND INTEREST RATE BEHAVIOR: A STOCHASTIC ORDER APPROACH

The aim of the paper is to show how changes in interest rate behavior, characterized in terms of stochastic orders of rate distributions, affect the banking industry. The basic feature of a banking firm is of a financial intermediary holding highly illiquid assets in the presence of liabilities which are typically liquid. We abstract from any information problem by not pursuing the issue of information-based bank panics or moral hazard aspects in managing risky assets. The bank management is simply a decision making unit arranging its portfolio on duration and interest rate considerations. Hence, interest rate distributions are the main ingredients of the analysis.