Interest Risk Factors and Stock Returns of US Banks: The Effects of Size and Financial Crisis

Abstract: We find that the effects of interest risk factors on US banks' stock returns are affected by banks' size, measured by market equity values, and income structures, measured by the ratios of interest income and interest expense. The effects of interest risk factors have changed after 2008 financial crisis. We regress banks' stock returns on risk factors and show that the loadings of interest risk factors either change from non-significant to significant or change from positive to negative after 2008 financial crisis. Such changes apply to all banking industry regardless banks' size, but the magnitude of changes increases as banks' size grows. The effects of financial crisis are associated with the changing economic environment, as well as banks' increasing interest income relative to interest expense. Furthermore, we find that simple measurements of interest risks such as changes of long-term Treasury returns or changes of long-term Treasury yields have consistent effects on US banks' stock returns, compared to other measurements such as unanticipated shocks in short-term interest rates.