Thesis on Capm and Its Applications: Interest Rate Sensitivity of Stock Returns
M.Sc. Economics and Finance Dissertation INTEREST RATE SENSITIVITY OF STOCK RETURNS
Acknowledgements
I would like to thank my supervisor Dr. Illias Tsiakas for his continued support and Encouragement. I would like to thank my father, mother and my sister for their tremendous support and understanding not only through the period of this thesis but for the period of the entire masters programme. In addition I would like to thank some of my friends who supported and encouraged me. Special thanks to Dr. Abhay Abhyankar for his assistance and help in the dissertation.
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Abstract
The volatility associated with interest rate movements and the risks arising from exposure to this volatility has made it an important subject of study. Most existing studies examining the phenomenon of interest rate sensitivity have focussed on its effects on the stock returns of banks and financial institutions. While it is certainly true that due to the nature of their activities such firms are bound to be significantly affected by interest rate movements. Nevertheless, interest rate movements also affect firms which are nonfinancial in nature. Little is known about the interest rate exposure faced by nonfinancial firms. One of the main contributions of this paper is that we have attempted to analyse the interest rate exposure of both financial as well as non-financial corporations simultaneously. This paper uses a three factor regression model, whereby we regress the returns on any chosen S&P 500 index on the returns on the S&P 500 composite index, changes in the domestic interest rates and changes in the global interest rates. In addition we have also explored the possibility that interest rate movements and stock returns could be related in a complex manner or are nonlinear functions of each other and therefore we explore the existence of nonlinear exposure profiles. A feature of this paper is that we have made an attempt to analyse and compare the results obtained for the
Acknowledgements
I would like to thank my supervisor Dr. Illias Tsiakas for his continued support and Encouragement. I would like to thank my father, mother and my sister for their tremendous support and understanding not only through the period of this thesis but for the period of the entire masters programme. In addition I would like to thank some of my friends who supported and encouraged me. Special thanks to Dr. Abhay Abhyankar for his assistance and help in the dissertation.
2
Abstract
The volatility associated with interest rate movements and the risks arising from exposure to this volatility has made it an important subject of study. Most existing studies examining the phenomenon of interest rate sensitivity have focussed on its effects on the stock returns of banks and financial institutions. While it is certainly true that due to the nature of their activities such firms are bound to be significantly affected by interest rate movements. Nevertheless, interest rate movements also affect firms which are nonfinancial in nature. Little is known about the interest rate exposure faced by nonfinancial firms. One of the main contributions of this paper is that we have attempted to analyse the interest rate exposure of both financial as well as non-financial corporations simultaneously. This paper uses a three factor regression model, whereby we regress the returns on any chosen S&P 500 index on the returns on the S&P 500 composite index, changes in the domestic interest rates and changes in the global interest rates. In addition we have also explored the possibility that interest rate movements and stock returns could be related in a complex manner or are nonlinear functions of each other and therefore we explore the existence of nonlinear exposure profiles. A feature of this paper is that we have made an attempt to analyse and compare the results obtained for the
Bibliography: 1 Sohnke.M.Bartram (2002) – “The Interest Rate Exposure of Non-Financial Corporations” : European Financial Review Volume pg 6, 101-125 17 Most of the empirical studies performed on interest rate exposures are primarily based on a two-index model developed by B.K.Stone (1974)5 which includes an interest rate change factor in addition to the ‘traditional’ market index model 5 Bernell.K.Stone (1974) – “Systematic Interest-Rate risk in a Two-Index Model of Returns”, The Journal of Financial and Quantitative Analysis”, vol.9, issue 5, pg 709-721. 6 Flannery and James (1984) – “The effect of Interest Rate Changes on the Common Stock Returns of Financial Institutions”, The Journal of Finance, vol.39, issue no.4, pg 1141-1153