Interest rate risk management in uncertain times

Abstract

We revisit evidence of real effects of uncertainty shocks in the context of interest rate uncertainty. We document that adverse movements in interest rate uncertainty predict significant slowdowns in real activity, both at the aggregate and at the firm levels. 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 data set on corporate swap usage.We find that interest rate uncertainty depresses financially constrained firms' investments in spite of hedging opportunities, because risk management by means of swaps is effectively risky.