Impact of interest rate risk on the Spanish banking sector 9mated:
Rit=ωi+λiRmt+θiIt+ηiDtIt+γiloghit+it (6)
hit=α 0 +α 1 ^2 it− 1 +βhit− 1 +δiVCIt− 1 (7)it| (^) t− 1 ∼N( 0 ,hit) (8)
whereDt=1ift≤January 1999 andDt=0ift>January 1999. Its associated
coefficient,ηi, reflects the differential impact in terms of exposure to IRR during the
pre-euro period. The results are reported in Table 5.
Ta b le 5 .Maximum likelihood estimates of the GARCH-M extended model with dummy vari-
able
Portfolio L Portfolio M Portfolio S
3 month 10 years Spread 3 months 10 years Spread 3 month 10 years Spread
θi 1.94 − 3. 44 − 1. 88 ∗∗∗ 2.42 2.59 − 0. 73 ∗∗∗ − 1. 69 − 0. 67 − 0. 17
ηi− 6. 52 ∗∗− 4. 69 ∗∗ 1.52∗∗ − 4. 57 ∗∗∗− 6. 53 ∗∗∗ 0.95∗∗∗ 0.13 − 3. 43 ∗∗∗− 0. 61 ∗∗
This table shows the IRR estimated parameters in the GARCH-M model following (6)–(8).
∗∗∗,∗∗and∗denote statistical significance at the 1%, 5% and 10% levels, respectively.
The coefficientηiis negative and significant at the usual levels in most cases
with the long- and short-term interest rate changes, whereas the results are not totally
conclusive with the spread series. This finding shows that the IRR is substantially
higher during the pre-euro period, in line with prior evidence (see [15]) and indicating
that interest rate sensitivity of bank stock returns has decreased considerably since
the introduction of the euro. The declining bank IRR during the last decade can be
basically attributed to the adoption of a more active role in asset-liability management
by the banks in response to the increase of volatility in financial markets, which has
led to more effective IRR management.
6 Conclusions
This paper examines the interest rate exposure of the Spanish banking sector within
the framework of the GARCH-M. In particular, the analysis has been carried out on
bank stock portfolios constructed according to size criteria. Following the most recent
strand of research, this study investigates the impact of both interest rate changes and
interest rate volatility on the distribution of bank stock returns.
The results confirm the common perception that interest rate risk is a significant
factor to explain the variability in bank stock returns but, as expected, it plays a sec-
ondary role in comparison with market risk. Consistent with previous work, bank
stock portfolio returns are negatively correlated with changes in interest rates, the