| Abstract: | The paper surveys current and previous research on financial institutions' interest rate risk exposure. The implications of such exposure are discussed and motivating insights are emphasized. Various theoretical frameworks and models are presented. For each one an overview of the studies and any relationship to each other is provided. In a cross‐industry analysis, other idiosyncratic risk factors are considered and their importance is delineated. A number of empirical relations are established. More specifically, there is an inverse relationship between interest rate changes and common stock returns of financial institutions. The intermediaries' apparent yield sensitivity is mainly attributed to the duration gap inherent in their balance sheet structure. Furthermore, the aforesaid equity sensitivity due to other possible dynamics such as dividend yield, unanticipated inflation and regulatory lags is also considered. Changes in economic regimes have altered volatility in market yields with a subsequent effect, positive or negative, on financial intermediaries' equity returns. The issue of the risk‐return compensation is further analyzed, and findings suggest that the interest rate risk is priced by capital markets. Finally, a few other issues are identified as avenues for future research. |
