Multi-risk premia model of us bank returns: An integration of CAPM and APT

Abstract

Interest rate sensitivity of bank stock returns has been studied using an augmented CAPM, a multiple regression model with market returns and interest rate as independent variables. In this paper, we test an asset-pricing model in which the CAPM is augmented by three orthogonal factors which are proxies for the innovations in inflation, maturity risk, and default risk. The model proposed is an integration of CAPM and APT. The results of the two models are compared to shed light on sources of interest rate risk. Our results using the integrated model indicate the inflation beta to be statistically significant. Hence, innovations in short-term interest rates contain valuable information regarding inflation premium; as a result the interest rate risk is priced with respect to the short-term interest rates. Further, it also indicates that innovations in long-term interest rates contain valuable information regarding maturity premium. Consequently the interest rate risk is priced with respect to the long-term interest rates. Using the traditional augmented CAPM, our investigation of the pricing of the interest rate risk is inconclusive. It shows that interest rate risk was priced from 1979 to 1984 irrespective of the choice of interest rate variable. However, during the periods 1974–1978 and 1985–1990, bank stock returns were sensitive only to the innovations in the long-term interest rates.​