Interest Rate Risk of German Financial Institutions - the Impact of Level, Slope, and Curvature of the Term Structure

Posted: 30 Jun 2006 Last revised: 17 Jun 2010

See all articles by Marc-Gregor Czaja

Marc-Gregor Czaja

Allianz Investment Management

Hendrik Scholz

Friedrich-Alexander-Universität Erlangen-Nürnberg

Marco Wilkens

University of Augsburg

Date Written: December 5, 2008

Abstract

We investigate here the sensitivity of the stock returns of German financial institutions to changes in the shape of the term structure of interest rates. The standard approach has been to measure the interest rate sensitivity of stock returns by focussing solely on changes in a single interest rate factor. We extend this approach to capture the sensitivity to changes in level, slope, and curvature of the term structure. More specifically, we use the parameters of the model by Nelson and Siegel (1987) to fit the term structure, which can be interpreted as the term structure's level, slope, and curvature. Applying multi-factor models, we find the level factor to be the single most important interest rate factor explaining stock returns. Nevertheless, neglecting the curvature factor would lead to a significant underestimation of the interest rate risk of financial institutions. The slope factor, on the other hand, has only minor importance for financial institutions. Moreover, we document both time-varying and industry-specific exposure to changes in the shape of the term structure. Finally, in an APT context, we test whether changes in level, slope, and curvature of the term structure are priced factors in the German equity market. We find the level and the curvature factor to be rewarded in the cross-section of expected returns in the German equity market, suggesting that both represent systematic risk factors.

Keywords: German financial institutions, interest rate sensitivity, term structure, Nelson-Siegel approach

JEL Classification: C52, G12, G21, G22

Suggested Citation

Czaja, Marc-Gregor and Scholz, Hendrik and Wilkens, Marco, Interest Rate Risk of German Financial Institutions - the Impact of Level, Slope, and Curvature of the Term Structure (December 5, 2008). Review of Quantitative Finance and Accounting, Vol. 33, pp. 1-26, 2009. Available at SSRN: https://ssrn.com/abstract=912239

Marc-Gregor Czaja

Allianz Investment Management ( email )

Reinsburgstr. 19
Stuttgart, 70178
Germany
+49-711-663-2122 (Phone)
+49-711-663-82122 (Fax)

HOME PAGE: http://www.allianz.com

Hendrik Scholz (Contact Author)

Friedrich-Alexander-Universität Erlangen-Nürnberg ( email )

Lange Gasse 20
Lange Gasse 20,
Nürnberg, 90403
Germany

Marco Wilkens

University of Augsburg ( email )

Universitaetsstr. 16
Augsburg, 86159
Germany
+49 821 598 4124 (Phone)
+49 821 598 4223 (Fax)

HOME PAGE: http://www.wiwi.uni-augsburg.de/bwl/wilkens/team/wilkens_marco/

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