HEDGING AND COORDINATED RISK MANAGEMENT - EVIDENCE FROM THRIFT CONVERSIONS

We provide an explanation for hedging as a means of allocating rather than reducing risk. We argue that when increases in total risk are cos tly, firms optimally allocate risk by reducing (increasing) exposure t o risks that provide zero (positive) economic rents. Our evidence show s that mutual thrifts that convert to stock institutions increase tota l risk, following conversion, consistent with their increased abilitie s and incentives for risk taking. They achieve this increase by hedgin g interest-rate risk and increasing credit risk. We provide some evide nce that risk-management activities are related to growth capacity and management compensation structure attained at conversion.