Sensitivity of the bank stock returns distribution to changes in the level and volatility of interest rate: A GARCH-M model |
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| Institution: | 1. Department of Finance, School of Business & Management, Temple University, Speakman Hall, Philadelphia, PA 19122, USA;2. School of Management, Widener University, One University Place, Chester, PA 19013, USA;1. Economics Section, Adam Smith Business School, University of Glasgow, Glasgow, UK;2. Economics Section, Cardiff Business School, Cardiff University, Cardiff, UK;1. Norwich Business School, University of East Anglia, Norwich Research Park, Norwich NR4 7TJ, UK;2. Department of Industrial Management and Technology, University of Piraeus, Greece |
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| Abstract: | The objective of this paper is to employ the generalized autoregressive conditionally heteroskedastic in the mean (GARCH-M) methodology to investigate the effect of interest rate and its volatility on the bank stock return generation process. This framework discards the restrictive assumptions of linearity, independence, and constant conditional variance in modeling bank stock returns. The model presented here allows for shifts in the volatility equation in response to the changes in monetary policy regime in 1979 and 1982 to be estimated. ARCH, GARCH, and volatility feed back effects are found to be significant. Interest rate and interest rate volatility are found to directly impact the first and the second moments of the bank stock returns distribution, respectively. The latter also affects the risk premia indirectly. The degree of persistence in shocks is substantial for all the three bank portfolios and sensitive to the nature of the bank portfolio and the prevailing monetary policy regime. |
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