DERIVATIVES, PORTFOLIO COMPOSITION, AND BANK-HOLDING COMPANY INTEREST-RATE RISK EXPOSURE

This article examines the role played by derivatives in determining th e interest rate sensitivity of bank holding companies' (BHCs) common s tock, controlling for the influence of on-balance sheet activities and other bank-specific characteristics. The major result of the analysis suggests that derivatives have played a significant role in shaping b anks' interest rate risk exposures in recent years. For the typical ba nk holding company in the sample, increases in the use of interest rat e derivatives corresponded to greater interest rate risk exposure duri ng the 1991-1994 period. This relationship is particularly strong for bank holding companies that serve as derivatives dealers and for small er, end-user BHCs. During earlier years, however, there is no signific ant relationship between the extent of derivatives activities and inte rest rate risk exposure. There are two plausible interpretations of th e relationship between interest rate derivative activity and interest rate risk exposure in the latter part of the sample period: one interp retation suggests that derivatives tend to enhance interest rate risk exposure for the typical BHC in the sample, while the other suggests t hat derivatives may be used to partially offset high interest rate ris k exposures arising from other activities. The analysis provides suppo rt for the first of these two interpretations.