TAILIEUCHUNG - The sensitivity of bank stock returns to market, interest and exchange rate risks

The government liability nominal yield curves are derived from UK gilt prices and General Collateral (GC) repo rates. The real yield curves are derived from UK index-linked bond prices (section 1 below describes these instruments). By appealing to the Fisher relationship, the implied inflation term structure is calculated as the difference of instantaneous nominal forward rates and instantaneous real forward real rates (section 2 makes clear exactly what these terms mean). The instruments used in the construction of the commercial bank liability curve are first converted into synthetic bonds, and the same method is then used to produce the commercial bank liability curve. | Journal of Banking and Finance 16 1992 983-1004. North-Holland The sensitivity of bank stock returns to market interest and exchange rate risks Jongmoo Jay Choi Elyas Elyasiani and Kenneth J. Kopecky Temple University Philadelphia PA 19122 USA Received June 1991 final version received January 1992 This paper presents and estimates a multifactor model of bank stock returns that incorporates market return interest rate and exchange rate risk factors. A model of the optimizing behavior of an international banking firm is used to derive the sensitivity coefficients of the alternative factors. Regression equations are estimated that are based on either actual or unexpected values of the underlying factors with a post-October 1979 time dummy variable and with a moneycenter bank dummy variable. Standard results are obtained for the market and interest rate variables while new results are derived for the exchange rate variable. The specific effects of the latter variable are found to be dependent on the time period of observation and the moneycenter status of banks. 1. Introduction The interest rate variable is important for the valuation of common stocks of financial institutions because the returns and costs of financial institutions are directly dependent on interest rates. Various authors have therefore examined the empirical sensitivity of stock returns of financial institutions to changes in market interest rates On the international side the advent of the flexible exchange rate system in the 1970s and the growing internationalization of the economy including the banking sector has introduced another macro financial variable the exchange rate as a potential determinant of bank stock returns. However no empirical study has yet been published that explicitly examines the joint interaction of exchange rates and interest rates on bank stock pricing. Correspondence to Professor Kenneth J. Kopecky School of Business Department of Finance Speakmen Hall Temple University .

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