Interest Rate Risk and Bank Equity Valuations

William B. English, Skander Van den Heuvel, Egon Zakrajsek
2012 Social Science Research Network  
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 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
more » ... ize of this mismatch and other bank characteristics. The 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. JEL Classification: G21, E43, E52
doi:10.2139/ssrn.2055292 fatcat:4y2qp67woffxzcdrngj4iec2qy