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Equity returns of financial institutions and the pricing of interest rate risk

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  • Sotiris Staikouras

Abstract

This study investigates the issue of whether financial intermediaries' common stock returns incorporate a risk premium for their inherent exposure to unexpected changes in interest rates. A wide range of financial institutions is employed to test the hypothesis that the interest rate risk is priced by capital markets. In addition, the above sample is extended by incorporating firms from the non-financial sector. A two-factor model with the market portfolio and the changes in market yields, as exogenously specified risk variables, is employed. The model is estimated via a seemingly unrelated regression estimation (SURE) framework with both cross-equation restrictions and within equation nonlinear constraints on the parameters. The findings indicate that financial institutions' equity returns incorporate a risk premium for their exposure to market yields' surprises. The return generating function of the insurance business could be further explained by an additional factor such as currency movements. It is also empirically supported that the market premium drops out from the estimation process. When commercial and industrial firms are included in the estimation process, the findings unveil a reduction in the magnitude of the interest rate risk premium.

Suggested Citation

  • Sotiris Staikouras, 2005. "Equity returns of financial institutions and the pricing of interest rate risk," Applied Financial Economics, Taylor & Francis Journals, vol. 15(7), pages 499-508.
  • Handle: RePEc:taf:apfiec:v:15:y:2005:i:7:p:499-508 DOI: 10.1080/09603100500039557
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    References listed on IDEAS

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    Cited by:

    1. Rajeev K. Goel, 2006. "Insurance intermediaries and contractual relations," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 2(4), pages 211-215, July.
    2. Francisco Jareno, 2008. "Spanish stock market sensitivity to real interest and inflation rates: an extension of the Stone two-factor model with factors of the Fama and French three-factor model," Applied Economics, Taylor & Francis Journals, vol. 40(24), pages 3159-3171.
    3. repec:eaa:aeinde:v:17:y:2017:i:2_5 is not listed on IDEAS
    4. Hippler, William J. & Hassan, M. Kabir, 2015. "The impact of macroeconomic and financial stress on the U.S. financial sector," Journal of Financial Stability, Elsevier, vol. 21(C), pages 61-80.
    5. M. Kabir Hassan & William J. Hippler III, 2013. "The Pronounced Impact of Macroeconomic Stress on the Financial Sector: Implications for Real Sector Growth," NFI Working Papers 2013-WP-01, Indiana State University, Scott College of Business, Networks Financial Institute.
    6. Apostolos Serletis & Jagat Jit Virk, 2006. "Monetary Aggregation, Inflation, and Welfare," World Scientific Book Chapters,in: Money And The Economy, chapter 5, pages 98-116 World Scientific Publishing Co. Pte. Ltd..

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