Time-varying market, interest rate, and exchange rate risk premia in the U.S. commercial bank stock returns

Abstract

This paper examines the role of market, interest rate, and exchange rate risks in pricing a sample of US. commercial bank stocks by developing and estimating a multi-factor model under both unconditional and conditional frameworks Three different econometric methodologies are used to conduct the estimations and testing The estimation results based on Nonlinear Seemingly Unrelated Regression (NLSUR) via GMM approach indicate that interest rate risk is the only priced factor in an unconditional multi-factor model However, based on Dumas and Solnik's (1995) "Pricing Kernel" approach, strong evidence of exchange rate risk is found in both larger bank and regional bank stocks, and only weak evidence of interest rate risk is found for regional bank stocks in a conditional multi-factor model with time-varying risk prices Finally, estimations based on the multivariate factor GARCH in mean approach where both conditional first and second moments of bank portfolio returns and risk factors are estimated simultaneously show strong evidence of time-varying market, interest rate, and exchange rate risk premia for all three bank portfolios, namely Money Center bank, Larger bank, and Regional bank.