Interest Rate Sensitivity, Asymmetry, and the Stock Returns of Financial Institutions

This paper attempts to reconcile the conflicting results reported in prior interest rate sensitivity studies that utilized the stock returns of financial institutions. By analyzing the interest rate elasticities during different interest rate cycles and adjusting for different monetary policy regimes, this paper suggests that sample period effects rather than methodological differences account for the conflicts presented in previous studies. More specifically, the empirical results indicate some asymmetrical interest rate sensitivities during various interest rate cycles. For example, the stock returns of savings and loan institutions were found to be more sensitive to falling interest rates. On the other hand, the stock returns of banks appeared to be more responsive to rising interest rates. Consequently, any attempt to employ models utilizing aggregated data either for policy making or to construct portfolio strategies will result in time aggregation bias and misguided decision making.