Sensitivity of Interbank Overnight Lending Rates and the impact on Banks’ Returns: An Asymmetric GARCH Approach
April 1st, 2017
By Muhammad Asghar Khan
This study employs an asymmetric GARCH model to investigate the relative sensitivities of lending rates and their impact of bank stock return distribution. Bank returns are instruments of money market which are affected by lending rates. This study analyzed the instability of lending rates and their impact on the bank returns. Asymmetric approach of GARCH is used to analyze the data. Two portfolios are formed representing the conventional and Islamic banks. Both conventional and Islamic banks have been taken from banks in Pakistan. The sample includes weekly, monthly, quarterly and semi-annual data over the 2012-2013 period. 3 banks (HBL, MCB and Allied) are selected for conventional portfolio and 3 banks selected for Islamic portfolio are Askari Islamic, Meezan and Bank Islami. The findings indicate that short term and long-term interest rates and their volatilities do exert significant and differential impacts on the return of bank portfolios. These findings have implications on bank hedging strategies against the interest rate risk, regulatory decisions concerning risk-based capital requirement, and investor’s choice of a portfolio mix.