Financial Engineering to Optimize Hedging in Banks Based on Derivatives to Better Withstand Stress Conditions the Case of Banks in Syria
Banks have limited options to withstand shocks in stress conditions. Therefore, financial engineering has been addressed as a particularly important hedging practice when banks cannot concentrate more risks on their books, or when the costs of selling assets are too high. This study uses derivatives to better hedge the exposure of banks to credit risk in stress conditions considering the case study of banks in Syria in optimizing hedging practices based on credit default swaps (CDS). The aim of this study is to use financial engineering to provide banks with a hedging technique to better absorb shocks in times of stress conditions. This has been discussed and illustrated with visual model diagrams. The case study of banks in Syria considered in this study is not just the story of individual banks but a window into how to hedge the exposure of banks in stress conditions. The recommendations set out in this study provide banks with an optimized hedging practice which is not part of current financial engineering at banks in Syria. Moreover, a hedging arbitrage has been developed to address whether derivatives have a hedging comparative advantage in terms of return on capital.