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Interest rate risk and bank equity valuations

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  • William B. English
  • Skander J. Van den Heuvel
  • Egon Zakrajsek

Abstract

Because they engage in maturity transformation, a steepening of the yield curve should, all else equal, boost bank profitability. We re-examine this conventional wisdom by estimating the reaction of bank intraday stock returns to exogenous fluctuations in interest rates induced by monetary policy announcements. We construct a new measure of the mismatch between the repricing time or maturity of bank assets and liabilities and analyze how the reaction of stock returns varies with the size of this mismatch and other bank characteristics, including the usage of interest rate derivatives. Our results indicate that bank stock prices decline substantially following an unanticipated increase in the level of interest rates or a steepening of the yield curve. A large maturity gap, however, significantly attenuates the negative reaction of returns to a slope surprise, a result consistent with the role of banks as maturity transformers. Share prices of banks that rely heavily on core deposits decline more in response to policy-induced interest rate surprises, a reaction that primarily reflects ensuing deposit disintermediation. Results using income and balance sheet data highlight the importance of adjustments in quantities--as well as interest margins--for understanding the reaction of bank equity values to interest rate surprises.

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File URL: http://www.federalreserve.gov/pubs/feds/2012/201226/201226abs.html
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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2012-26.

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Date of creation: 2012
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Handle: RePEc:fip:fedgfe:2012-26

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  1. Memmel, Christoph, 2010. "Banks' exposure to interest rate risk, their earnings from term transformation, and the dynamics of the term structure," Discussion Paper Series 2: Banking and Financial Studies 2010,07, Deutsche Bundesbank, Research Centre.
  2. Ehrmann, Michael & Fratzscher, Marcel, 2004. "Taking stock: monetary policy transmission to equity markets," Working Paper Series 0354, European Central Bank.
  3. Joao F. Gomes & Leonid Kogan & Motohiro Yogo, 2007. "Durability of Output and Expected Stock Returns," NBER Working Papers 12986, National Bureau of Economic Research, Inc.
  4. Gurkaynak, Refet S & Sack, Brian & Swanson, Eric T, 2005. "Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," MPRA Paper 820, University Library of Munich, Germany.
  5. Monika Piazzesi & Eric Swanson, 2004. "Futures Prices as Risk-adjusted Forecasts of Monetary Policy," NBER Working Papers 10547, National Bureau of Economic Research, Inc.
  6. Priyank Gandhi & Hanno Lustig, 2010. "Size Anomalies in U.S. Bank Stock Returns: A Fiscal Explanation," NBER Working Papers 16553, National Bureau of Economic Research, Inc.
  7. Arellano, Manuel, 2003. "Panel Data Econometrics," OUP Catalogue, Oxford University Press, number 9780199245291.
  8. John Ammer & Clara Vega & Jon Wongswan, 2010. "International Transmission of U.S. Monetary Policy Shocks: Evidence from Stock Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 179-198, 09.
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