Barriers to depository uses of derivatives: an empirical analysis

We examine the relationship between derivatives use of US savings associations during 1993–1997. The advantage of examining thrifts is that they are only end-users of derivatives. We find that: (1) firm size positively correlated with derivatives use generally and to OTC derivatives use in particular; (2) the dominant underlying reason for the effect of firm size upon derivatives usage appears to be transactions cost, not the cost of acquiring the expertise to manage portfolio interest rate risk; and (3) the use of derivatives, especially OTC derivatives, is a least cost method of controlling interest rate risk. The lack of usage by smaller institutions, while consistent with profit-maximization, suggests that a significant segment of the industry is limited in its ability to manage interest rate risk.