The Effect of Interest Rate Changes on the Common Stock Returns of Financial Institutions

Authors

  • MARK J. FLANNERY,

  • CHRISTOPHER M. JAMES

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    • University of North Carolina and University of Oregon, respectively. Special thanks go to Ron Masulis and Wayne Ferson for lengthy discussions on the subject of this paper. We would also like to thank Larry Dann, Mike Hopewell, Megan Partch, George Racette, Richard Startz, Alden Toevs, and Peggy Wier for helpful discussion and criticisms. Sally Collier, Kathi Martell, and Diane Mayer provided excellent research assistance. A portion of this study was undertaken while the first author was a research advisor to the Federal Reserve Bank of Philadelphia and the second author was a consultant to the Comptroller of the Currency. The views expressed here in no way represent those of the Federal Reserve Bank of Philadelphia or the Comptroller of the Currency.

ABSTRACT

This paper examines the relation between the interest rate sensitivity of common stock returns and the maturity composition of the firm's nominal contracts. Using a sample of actively traded commerical banks and stock savings and loan associations, common stock returns are found to be correlated with interest rate changes. The co-movement of stock returns and interest rate changes is positively related to the size of the maturity difference between the firm's nominal assets and liabilities.

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