3.1. BANK EQUITY VALUES AND INTEREST RATE CHANGES
Prior studies of the interest rate sensitivity of bank equity returns have examined
a number of issues using both two and three factor asset pricing models. Flannery
and James (1984) document a significant relationship between the interest
rate sensitivity of common stock returns of financial institutions and the maturity
composition of their nominal contracts. Tarhan (1987) documents the relationship
between unanticipated movements in interest rates and bank stock prices where
unanticipated interest rate movements are captured by the residuals of an interest
rate forecasting equation (an ARIMA model fitted on daily three-month T-bill
rates). He also measures unexpected interest rate movements by estimating money
supply announcement induced interest rate movements.
Yourougou (1990) documents interest rate sensitivity of weekly equity returns
for banks, S&Ls, and industrial firms for the period October 21, 1977 to December
24, 1981. Yields on three-year Treasury securities are used to generate unexpected
interest rate changes using an ARIMA model for a two-factor (market and interest
rate) asset pricing model. Akella and Chen (1990) examine interest rate sensitivity
of 23 bank stock returns using a two factor pricing model from 1974 to 1984 under
alternative methods for orthogonalizing variables. Also using a two factor model,
Robinson (1995) documents that the sensitivity of U.S. bank equity returns to unexpected
changes in both short and long term interest rates has changed over time and
with the regulatory environment. Madura and Zarruk (1995) also use a two-factor
model to document the sensitivity of U.S. Canadian, German, Japanese, and U.K.
banks to orthogonalized unanticipated interest rate changes. Saporoschendo (2002)
investigates the sensitivity of Japanese bank stock returns to various economic factors
and finds that Japanese bank stock prices are negatively related to long-term
interest rate innovations.