Kenneth J. Kopecky

The Sensitivity of Bank Stock Returns to Market, Interest and Exchange Rate Risks

This paper presents and estimates a multifactor model of bank stock returns that incorporates market return, interest rate and exchange rate risk factors. A model of the optimizing behavior of an international banking tirm is used to derive the sensitivity coefficients of the alternative factors. Regression equations are estimated that are based on either actual or unexpected values of the underlying factors with a post-October 1979 time dummy variable and with a moneycenter bank dummy variable. Standard results are obtained for the market and interest rate variables while new results are derived for the exchange rate variable. The specific effects of the latter variable are found to be dependent on the time period of observation and the moneycenter status of banks. The interest rate variable is important for the valuation of common stocks of financial institutions because the returns and costs of financial institutions are directly dependent on interest rates. Various authors have, therefore, examined the empirical sensitivity of stock returns of financial institutions to changes in market interest rates. ’ On the international side, the advent of the flexible exchange rate system in the 1970s and the growing internationalization of the economy, induding the banking sector, has introduced another macro financial variable, the exchange rate, as a potential determinant of bank stock returns. However, no empirical study has yet been published that explicitly examines the joint interaction of exchange rates and interest rates on bank stock pricing.

Does the stock market predict real activity? Time series evidence from the G-7 countries

This paper extends one aspect of the US stock market study of Fama (1990) and Schwert (1990). We examine the relationship between industrial production (IP) growth rates and lagged real stock returns for the G-7 countries using both in-sample cointegration and error-correction models and the out-of-sample forecast-evaluation procedure of Ashley et al. (1980). The cointegration tests show a long-run equilibrium relationship between the log levels of IP and real stock prices, while the error-correction models indicate a correlation between IP growth and lagged real stock returns for all countries except Italy. The out-of-sample tests show that in several sub-periods the US, UK, Japanese, and Canadian stock markets enhance predictions of future IP. ” 1999 Elsevier Science B.V. All rights reserved.

Common factors in international stock prices: Evidence from a cointegration study

Abstract This paper uses multilateral and bilateral cointegration techniques to examine the stock market behavior of the seven major industrial countries (Group of Seven) over the 1970–1989 period and to determine the consistency of three alternative hypotheses with the available evidence. As explanations of the common trend in stock prices, the hypotheses include technological change, trade liberalization and financial deregulation. Our results show that none of the three macroeconomic hypotheses are consistent with all the cointegration tests . When all the countries are included, the tests indicate the presence of at least one common trend among the stock price levels , a finding that is also consistent with a multifactor international asset-pricing model. However, as we proceed to disaggregate to smaller sets of countries, including all the bilateral relations as the smallest possible subset, the finding of a common trend becomes more tenuous. Overall, our results indicate that each of the three hypotheses has empirical support over both different subgroups of countries and periods of estimation.

A model of the monetary sector with and without binding capital requirements

Abstract Bank equity is exogenous in the standard deposit-and-loan-expansion multiplier model, so that model is inappropriate for analyzing the interaction between monetary and bank regulatory policies. This paper examines the effect of a binding capital requirement on the loan expansion process. We evaluate how the conflict between the monetary and regulatory authorities evolves when bank equity adjusts to a binding capital requirement. We find that capital requirements are not innocuous for monetary policy. Nevertheless, the monetary authority can assert control over the loan expansion process in the long run, although multiplier values will differ considerably from those in the standard multiplier model.

Domestic macroeconomic news and foreign interest rates

Abstract This study examines the impact of US and UK news on futures prices of US, UK, German, and Japanese government bonds. We find that certain US information has a significant influence on German, Japanese, and British interest rates, while UK information has almost no effect on foreign rates. Second, we examine the foreign term structure to investigate whether the importance of US information arises because it either signals common world-wide shocks or induces an anticipated exchange rate stabilization by foreign central banks. The evidence is mixed, except for the US CPI surprise which appears to provide information about a common world-wide shock. (G15).

Interest rate smoothness and the nonsettling-day behavior of banks

Abstract The variance of federal funds rates on nonsettling days was relatively low during the nonborrowed reserve period. As an explanation, we develop a model where banks maximize expected profits over the reserve maintenance period subject to transaction costs on the settling day (for simplicity, fixed costs) and a probability distribution of stochastic reserve flows. The equilibrium solution reveals the relation between the microeconomic parameters—settling-day transaction costs and the reserve flow variance—and the variance of nonsettling-day rates. Casual evidence suggests that regulatory innovations may have altered the reserve flow variance to produce the observed degree of interest rate smoothness.

Technology Adoption over the Life Cycle and Aggregate Technological Progress

Technology becomes useful only when individuals adopt it for productive activity. The manner in which adoption occurs is therefore important for a complete understanding of the evolution of technological change. We study a model with exogenously occurring technological progress and endogenous adoption of it. Individuals with N-period lives optimally allocate their time between leisure, work and adoption of new technology. We show that optimal behavior is characterized by a sequence of four phases of life which, described in their order of occurrence, are: (1) adoption only (schooling); (2) work and adoption (career path); (3) work but no adoption (end-of-work-life easing); (4) no work or adoption (retirement). The presence of the third phase, a period in which older workers choose not to adopt new technology, has several implications for the effects of changes in aggregate exogenous technology. Among these is the implication that a wave of innovation will have a smaller effect when the number of workers in this phase is relatively large. This is tested using patent data as a proxy for innovation and the Solow residual as a measure of technological progress; some support for this proposition is found. The model also implies that older (third phase) workers will appear more productive because each hour of non-leisure time will be devoted entirely to productive work, rather than being divided between work and technology adoption time. The data provides some support for this proposition as well: measured productivity is positively correlated with the relative size of the oldest cohort of workers.

Health, lifespan and economic activity: why poor nations remain poor and rich nations rich

The level of health attained by a nations citizens will affect their economic behavior in many important respects. We focus on one of these - the effect of health on expected lifespan. When individuals expect to live for a longer period of time, they plan accordingly earlier in their lives. Specifically, longer-lived individuals have a greater incentive early in life to devote a larger and perhaps longer portion of their time to human capital accumulation. This can take the form of a longer schooling period, greater attention to studying while at school, or a greater willingness to engage in an apprenticeship or other low-wage learning-by-doing work. The incentive to learn is perhaps more important in the learning process than more easily measured items such as school attendance. We apply this analysis to the long-standing puzzle of why some nations have remained permanently in a state of underdevelopment and impoverishment. We demonstrate that expected lifespan can affect income levels, and we note that income levels can affect health and thereby lifespan. This mutual dependence can cause rich countries to remain rich and poor nations to remain poor. If the analysis is valid, there are important policy implications including: public health expenditures can have very long-term benefits; health resources directed at older citizens can contribute to economic development; and without adequate health and concomitant lifespan, individuals will not have sufficient incentive to take advantage of educational opportunities no matter how many resources are made available to them.