Linear and nonlinear interest rate sensitivity of Spanish banks

Abstract

Interest rate risk is one of the major financial risks faced by banks due to the very nature of the banking business. The most common approach in the literature has been to estimate the impact of interest rate risk on banks using a simple linear regression model. However, the relationship between interest rate changes and bank stock returns does not need to be exclusively linear. This article provides a comprehensive analysis of the interest rate exposure of the Spanish banking industry employing both parametric and non parametric estimation methods. Its main contribution is to use, for the first time in the context of banks' interest rate risk, a nonparametric regression technique that avoids the assumption of a specific functional form. Linear and Nonlinear ABSTRACTInterest rate risk is one of the major financial risks faced by banks due to the very nature of the banking business. The most common approach in the literature has been to estimate the impact of interest rate risk on banks using a simple linear regression model. However, the relationship between interest rate changes and bank stock returns does not need to be exclusively linear. This article provides a comprehensive analysis of the interest rate exposure of the Spanish banking industry employing both parametric and non parametric estimation methods. Its main contribution is to use, for the first time in the context of banks' interest rate risk, a nonparametric regression technique that avoids the assumption of a specific functional form. One the one hand, it is found that the Spanish banking sector exhibits a remarkable degree of interest rate exposure, although the impact of interest rate changes on bank stock returns has significantly declined following the introduction of the euro. Further, a pattern of positive exposure emerges during the post-euro period. On the other hand, the results corresponding to the nonparametric model support the expansion of the conventional linear model in an attempt to gain a greater insight into the actual degree of exposure. J.E.L. Classification: G12, G21, C52Keywords: interest rate risk, banking firms, stocks, nonparametric regression techniques. Corresponding author. Departamento de Economía Financiera y Actuarial, Universidad de Valencia, Facultad de Economía, Avda. Tarongers, s/n, 46022 Valencia, Spain. Laura.Ballester@uv.es. Laura Ballester would like to express her gratitude for the funding received from the JCCM, proyecto PEII11-0031-6939. The authors would like to thank Alfonso Novales, Juan Nave, Ángeles Fernández, Paz Jordá, Miguel Ángel Martínez, Joaquín Maudos, and Eliseo Navarro for their valuable comments and suggestions. The authors are also grateful to the two anonymous referees for their comments that have contributed to improve this paper. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 6...

Exchange Rate and Interest Rate Exposure of UK Industries Using First‐order Autoregressive Exponential GARCH‐in‐mean (EGARCH‐M) Approach

“…Although they found that more industries were significantly exposed to the long-term interest rate than the short-term interest rate, however the exposure coefficients were negative for both interest rate measures. This result is similar to that of Ballester et al (2011) who for Spanish banks find significant negative interest rate exposure coefficients for both the short-term and the long-term interest rate. Zhou and Wang (2012) examine the exchange rate exposure of 148 UK non-financial firms using the trade-weighted index for the year 1999.…”

“…This result is similar to that of Ballester et al . () who for Spanish banks find significant negative interest rate exposure coefficients for both the short‐term and the long‐term interest rate.…”

“…Ballester et al . () also posit that the euro should bring about greater financial stability due to the common monetary policy and enlargement of the capital markets. Following on Morana and Beltratti (), Sfakianakis (), Bris et al .…”

“…Additionally, Korkeamäki (2011) noted that with the single currency, European corporate bonds markets, which were previously limited in size and scope have witnessed significant growth; thereby euro firms and even EU countries are able to manage interest rate risk more effectively. Ballester et al (2011) also posit that the euro should bring about greater financial stability due to the common monetary policy and enlargement of the capital markets. Following on Morana and Beltratti (2002), Sfakianakis (2002), Bris et al (2006), Simpson and Dania (2006), Korkeamäki (2007), Nguyen et al (2007), Hutson and O'Driscoll (2010) and Korkeamäki (2011), the period after the euro is chosen to start from 1 January 1999.…”

“…For instance, fluctuations in exchange rates can impact the cash flows of multinational firms, importers, exporters, and also purely domestic firms (Hyde, 2007;Lin, 2012). Similarly, movements in interest rates can also impact the firm's cash flow by altering the firm's cost of finance, impinging on the amount of principal and loan interest payable (Hyde, 2007) and also the value of its financial assets and liabilities (Bartram, 2002;Ballester et al, 2011;Park and Choi, 2011). Joseph (2002) further explains that changes in exchange rates and interest rates can affect the domestic and global competitiveness of firms, by making their inputs and outputs cheaper or more costly.…”