خطر نرخ بهره و ایجاد کمیته سیاست پولی: شواهدی از سهام های بانک ها و بیمه عمر شرکت ها در بریتانیا

This paper investigates the effect that the creation of the Monetary Policy Committee (MPC) has had on the interest rate risk which banks and life insurance companies face in the UK. By means of GARCH-M methodology, the stock returns are modelled on the CAPM and the Fama-French asset-pricing models, augmented with interest rate risk factors and referring to short- and long-term rates. Our results indicate that in the period before the Bank of England (BoE) was granted operational independence, changes in the level and volatility of interest rates significantly affected the stock returns of these companies. These effects have diminished since the MPC's creation in May 1997. In parallel, since the MPC's creation, macroeconomic uncertainty, as proxied by the MPC dissents, coexisted with significant effects on the short-term interest rate risk which banks and life insurance companies face. These results should be of interest to both analysts and policy-makers with respect to financial stability.

Interest rate risk is one of the most significant risks which banks and life insurance companies face, largely because of (1) a duration mismatch between their assets and liabilities and (2) the significant volatility of interest rates. Consequently, the inadequate risk management practices of banks and life insurance institutions can often lead to the structural vulnerability of the entire financial system and thus to financial crises. There is a large body of literature that provides empirical evidence of a strong negative relation between stock returns of financial firms and interest rates (e.g., Carson et al., 2008, Elyasiani and Mansur, 2003, Flannery et al., 1997, Flannery and James, 1984, Lloyd and Shick, 1977, Santomero and Babbel, 1997 and Viale et al., 2009). Choi, Elyasiani, and Saunders (1996), Allen and Jagtiani (1997), Hirtle (1997), and Benink and Wolff (2000) conclude, however, that interest rate sensitivity decreased in the late 1980s and early 1990s because of the availability of interest rate derivatives contracts that can be used for hedging purposes. Additionally, some authors argue that the interest rate dependence of financial stocks is time-variant and depends on economic conditions and monetary policy regimes (e.g., Booth et al., 1985, Brewer et al., 2007, Choi et al., 1992, Elyasiani and Mansur, 1998, Ferrer et al., 2010, Kane and Unal, 1988, Korkeamäki, 2011 and Yourougou, 1990). An important point that should be taken into account, however, when we investigate the effect of interest rate risk on banks and life insurance companies is the way in which monetary policy is conducted. In recent years, this conduct may have had a significant effect on interest rate risk exposures of banks and life insurance companies, to the extent that monetary policy implementation has changed significantly, along with the banking industry. In most developed countries, central banks conduct their monetary policy either by targeting a short-term interest rate or by setting an official interest rate for their open market operations. These policy rates anchor the entire term structure of interest rates. Nowadays, it is widely accepted that the ability of a central bank to affect the economy depends critically on its ability to influence market expectations about the future path of overnight interest rates and not merely their current level. The reason is simple. Few, if any, economic decisions hinge on the overnight bank rate cost and availability of bank reserves. Consequently and in order to significantly affect expectations of future policy rate changes, central banks follow institutional reforms for greater transparency in monetary policy implementation framework to reinforce their credibility (see the empirical evidence in Eijffinger & Geraats, 2006). More specifically, central bank independence (CBI) through its effect on central bank transparency (CBT; Geraats, 2002) and credibility (CBC; Rogoff, 1985) increases market operators’ acceptance of monetary policy and the ability of the central bank to fulfil its objectives. The Bank of England adopted inflation targeting in December of 1992 and was granted operational independence with the creation of Monetary Policy Committee (MPC) in May 1997. Therefore, a crucial question arises: ‘How did the creation of the Monetary Policy Committee (MPC) and its members’ dissents regarding policy rate affect the interest rate risk which financial services companies faced?’ Inflation expectations reflected in long-term rates are anchored, under high level of CBT. Therefore changes in the level of long-term rates and/or in the volatility of short-term rates (implying term structure movements) are not expected to affect investors’ and financial firms’ behaviour. According to our knowledge there has been no empirical evidence in this regard, a gap this paper attempts to fill. The literature on the effects of the creation of the BoE's MPC is still limited. For an excellent review of the effect of the MPC's creation on the macroeconomic performance of the UK see King, 2002 and King, 2007. Chadha and Nolan (2001) use data before and after MPC's creation to assess whether a change to a more transparent monetary policy caused an increase in the volatility of interest rates in financial markets, but find no evidence in support of this hypothesis. In the same vein, Clare and Courtenay (2001) found that the independence of the BoE has influenced the reaction speed of exchange rates and futures contracts to macroeconomic news. Tuysuz (2011) argued that even if agents have been able to forecast policy rates decisions more accurately since May 1997, there is no clear impact of BoE independence on the reaction of interest rate levels to macroeconomic and monetary news. Studying a number of central banks, Cihak (2006), Klomp and de Haan (2009) argue for a positive relation between CBI and financial stability, but no attention has been paid to an asset-pricing framework. Additionally, according to Alesina and Summers (1993), the variability of interest rates also reduces with higher CBI. Empirical evidence for the effect of CBI on interest rate risk facing financial services companies remains under investigation. Therefore our study contributes to the existing literature by evaluating the effect of short-term and long-term interest rate levels and changes in conditional volatilities on banks’ and life insurance companies’ stock returns in asset-pricing models with an exogenous structural break in May 1997. Moreover, the correlation between the MPC dissents in voting records and the interest rate risk exposure are investigated. There are times where the state of the economy is difficult to read and naturally there are differences of interpretation which lead to split votes. Equally, there are times where the nature of the economic shocks is not in dispute and the response of the MPC is agreed by all members. These events might have a significant impact on the ability of investors and financial services companies to forecast interest rates. Therefore, an investigation of interest rate effects that takes into account institutional reforms for greater transparency in monetary implementation can provide useful answers to important research questions concerning financial management strategies, banking regulation, and conduct of monetary policy. The rest of the paper is organised as follows. Section 2 provides the main theoretical arguments concerning the effect of interest rate changes on banks’ and life insurance companies’ equity returns. Section 3 offers a brief survey of previous literature. Section 4 provides information about the data and the main methodology of our research. Section 5 presents and discusses the results. Section 6 concludes the paper.

This study, by using extended CAPM and Fama-French models, investigates the effect of BoE independence on the interest rate risk that banks and life insurance companies face. Previous research on interest rate risk neglects the dissimilar contribution of unexpected components to equity returns in two different monetary policy frameworks: one with an increased level of transparency induced by the Monetary Policy Committee's actions and the other with a low level of transparency resulting from a low level of monetary policy independence. In the case of the UK, the weak effects concerning interest rate risk factors found by Beirne et al. (2009) can be attributed to the fact that they estimate sensitivities over the whole sample, whereas a significant structural change concerning monetary policy conduct occurred specifically in 1997. Our study shed light on this direction suggesting a model for measuring interest rate sensitivities to other countries experienced significant changes in the way that monetary policy is conducted. We use more than one interest rate factor in line with Czaja, Scholz, and Wilkens (2009) and Caporale and Perry (2006), and in contrast with the majority of the studies in the field focusing only on one interest rate risk factor (usually changes in the level). Empirical evidence is provided for the belief that the creation of MPC can reduce the interest rate risk that banks and life insurance companies face. Specifically, before the MPC's creation interest rate risk factors had a significant negative effect on stock returns. On the one hand, a positive change in long-term rates significantly lowers excess bank and life insurance stock returns. This is consistent with Elyasiani and Mansur's (1998) findings for US banks and with the view that changes in long-term real interest rates provide market participants with procyclical indications about future economic conditions. Lower (higher) interest rates during a contracting (expanding) and more (less) risky economy would raise (lower) the equity risk premium. On the other hand, an increase in short-term rate volatility implying term structure change also has a negative effect on excess return. After the MPC's creation there is no significant effect for any of our cases. Our results are consistent across different asset-pricing models, across financial services companies and across industry-level data and firm-level data. The last indicate the robustness of our findings given the trade-off between using industry-level data and using firm-level data. Moreover, according to King (2007), periods of increased uncertainty about the macro model that fits better with the real economy are reflected in MPC dissents. Using this argument we show that these dissents about the state of the economy coexist with a high level of interest rate risk that banks and life insurance companies face. Because of the different investment strategies of the two industries, banks are affected by changes in the level of short-term rates and life insurers by changes related to term structure (i.e., short-term rates’ conditional volatility). Therefore the beneficial role that a low level of dissents in MPC can have on reducing interest rate risk can be inferred. Our findings have important implications for monetary authorities seeking to foster stability in the financial industry via central banking policies. If we accept (as Romer & Romer, 2000 and Caporale & Perry, 2006 do) that the central bank has a significant information advantage over the public about the current and future state of the economy, monetary policy actions reflected in interest rate factors signal to the financial markets an increase (decrease) in economic risk, which necessitates a rise (fall) in the risk premium. These effects are not, however, present during the post-MPC period and during periods with no MPC dissents, mainly because investors can clearly identify central bank actions and therefore do not overreact to changes in interest rate factors. In this respect our evidence suggests that transparent policies with reduced uncertainty about monetary actions can reduce the negative effect of interest rate risk on financial services companies. Our analysis also suggests that to test the Efficient Market Hypothesis in a monetary policy framework characterised by a low level of central bank operational independence it is crucial to model the risk premium in financial services stocks by taking into account interest rate risk factors. Therefore, our results are interesting for managers, investors and policy-makers alike.