What Motivates Banks to Use Derivatives: Evidence from Taiwan

Banks listed on the Taiwan Stock Exchange disclose detailed derivatives information for the period 1998 to 2005 that allows us to examine the determinants of derivatives use. Using specific bank characteristic variables that proxy for the motivations and effects of participating in the derivatives market and end-quarter transaction volumes, we investigate the rationale for derivatives use. Using pro bit and panel data methods, we examine whether risk management, informational, and economics of scale arguments as well as agency and managerial explanations are good predictors of observed activity. Our results support the evidence of prior studies that risk management, informational, and scale factors explain the use of derivatives. We also observe a substitution effect that suggests a rational approach. to the participation decision. However, we find no support for agency and managerial motives, which we partly attribute to the specific regulatory legal, and cultural environment that exists in Taiwan.