Derivative activities and Asia-Pacific banks' interest rate and exchange rate exposures

In this paper, we investigate whether the level of derivative activities of Asia-Pacific banks is associated with the market's perception of their interest rate and exchange rate risks. The results suggest that the level of derivative activities (especially interest rate derivatives) is positively associated with long-term interest rate exposure (LTIR) but negatively associated with short-term interest rate exposure (STIR). Further investigations reveal that the positive LTIR exposures are driven by banks with extensive derivative activities. We do not find any significant association between banks' derivative activities and exchange rate exposure. The significant positive association between the level of derivative activities and LTIR suggests the need for better management of banks' internal control systems and/or greater derivative disclosure requirements to bring stronger market discipline to banks, particularly for banks with extensive derivative activities.