INTEREST RATE AND EXCHANGE RATE RISK IN FINANCIAL AND

NON-FINANCIAL INDUSTRIES: AN INTERNATIONAL STUDY

James P. Murtagh
Lally School of Management & Technology
Rensselaer Polytechnic Institute
Troy, New York 12180

Wolfgang Bessler
Professor of Finance
Center for Finance and Banking
Justus-Liebig-University Giessen, Germany

JEL Codes: G12, G15

Current version: January 2003

Please do not quote.

Corresponding author: James P. Murtagh, Lally School of Management & Technology, Rensselaer
Polytechnic Institute, Troy, New York 12180, email: murtaj@rpi.edu, phone: 518-276-2758, fax: 518-276-
2387.
INTEREST RATE AND EXCHANGE RATE RISK IN FINANCIAL AND
NON-FINANCIAL INDUSTRIES: AN INTERNATIONAL STUDY

ABSTRACT
In this paper we explore the sensitivity of monthly returns for financial and non-financial indices in

Canada, Germany, Japan, UK and US. An Ordinary Least Squares market model is applied and our results indicate

that interest rate and exchange rate sensitivity is more prevalent in financial stock index returns than in the non-

financial index in the same country, particularly banks. However, interest rate and exchange rate sensitivity varies

across countries. This relationship holds for most countries investigated in this study. Results find interest rate

sensitivity in financial and non-financial indexes, however the size and sign of coefficients are opposite between the

financial and non-financial indexes, lending further support to the notion that financials are special in their reaction

to interest rate changes.

INTEREST RATE AND EXCHANGE RATE RISK IN FINANCIAL AND
NON-FINANCIAL INDUSTRIES: AN INTERNATIONAL STUDY

I. INTRODUCTION
Since the end of the 1970s, the interest rate sensitivity of bank stock returns has been the focus of a

substantial amount of research, primarily by developing and testing multi-index-models. Incorporating interest rates

as an independent variable in an extended version of the market model was first suggested by Stone (1974), but it is

also supported by the work of Merton (1973) and Ross (1977). Following the literature on asset pricing models,

interest rate sensitivity of stock returns can be empirically tested either in an extended Capital Asset Pricing Model

framework or in an Arbitrage Pricing Theory framework. Independent of the theoretical framework employed, most

of the studies for depository institutions in the United States support the notion that returns of bank stocks are more

sensitive to changes in interest rates than is usually captured in the market index providing some evidence that banks

are special.

If banks are special and if banks are especially exposed to interest rate risk due to the very nature of the

banking business, then one would expect that this relationship would hold for banks stock returns in most countries.

To argue that banks are special and that the return generating process for banks is different from that of industrial

firms also requires to provide empirical evidence that non-banks are not interest rate sensitive or at least show less

interest rate sensitivity. This important aspect has been usually overlooked in the literature in that the focus of most

of the research has been on financial institutions only. It appears possible, however, that most firms (financial and

non-financial) in one country react sensitive to changes in interest rates. In this case, a two-factor model instead of a

single-factor model (market model) would be the model that best describes stock returns in that particular financial

market. What also usually has been omitted in the empirical research is an investigation of the stability of the

relationship including the question whether certain events have altered the relationship between interest rate changes

and bank stock returns.

The purpose of this study is to enhance our knowledge of the behavior of bank stock returns by

investigating their interest rate sensitivity. We take the following approach. We investigate the interest rate

sensitivity of stock returns of banks as well as of nonfinancial indexes. In addition to interest rate sensitivity, we

also explore whether banks and industrial firms in these countries are especially exposed to changes in exchange
rates, that is, exposed beyond the impact of exchange rate changes on the market index. We also explore whether

the returns of the market index in each country can be explained by changes in interest rates and exchange rates.

Our empirical investigation supports the notion that banks in most countries are exposed to changes in

interest rates and exchange rates. In contrast, non-financial firms in most countries usually do not react to changes in

interest rates. The results for exchange rates are mixed. From this study we can conclude that in most countries

banks stocks react significantly to changes in interest rates and exchange rates but that non-financial firms are

usually less sensitive to these factors supporting the notion that banks are special.

The rest of the paper is organized as follows. In the next section we review the literature concerning the

interest rate and exchange rate sensitivity of banks stocks. In section III we describe our data and the test

methodology. Our results are presented in section IV and section V concludes the paper.

II. REVIEW OF LITERATURE

a. Interest rate sensitivity

The sensitivity of stock returns to changes in interest rates has been extensively studied in the literature

dating back to the 1970s [Merton, (1973). Stone, (1974), Ross, (1976)]. These studies have utilized different

methodologies and interest rate measures but have generally supported the notion that some industry indices and

individual firms do exhibit additional sensitivity to changes in interest rates above that which is captured in the

market index. Various explanations are given for the existence of this interest rate sensitivity. In addition to the

general arguments that firms may be exposed to interest rate risk, many studies focus on the special interest rate

sensitivity of financial intermediaries [Saunders and Yourougou (1990)].

Though widely studied, the empirical literature concerning interest rate risk shows mixed results. There is

considerable variation in the model specifications, particularly in the chosen interest rate measures. The earlier

studies [e.g., Lloyd and Shick (1977), Martin and Keown (1977), Lynge and Zumwalt (1980), Flannery and James

(1984a, 1984b), and Booth and Officer (1985)] found evidence that bank stocks show interest rate sensitivity above

their responsiveness to changes in the market portfolio. Only Chance and Lane (1980) fail to confirm these findings.

Scott and Peterson (1986, p. 328) updated previous studies and again found interest rate sensitivity. Unal and Kane

(1988) tested a statistical market value accounting model that included interest rate sensitivity of recorded and
unrecorded elements of a bank's balance sheet. They reconciled some of the earlier findings and conclude that bank

stock returns respond inversely to changes in long term interest rates supporting the argument that positive maturity

transformation activities may influence bank stock returns. Bae (1990) reported that current and unanticipated

interest rate changes have a significant impact on bank stock returns, but that stock returns are not sensitive to

anticipated interest rate changes. This signifies that current interest rate changes are a good proxy for unanticipated

interest rate changes. Akella and Chen (1990) confirmed that bank stocks are sensitive to long term bond returns,

but less sensitive to a short term interest rate index. Moreover, they found evidence that the interest rate sensitivity

has declined towards the end of the 1980s. A decline in interest rate sensitivity during the 1980s was also confirmed

by Neuberger (1991).

The presence of interest rate sensitivity is also supported in studies by Yourougou (1990), Kwan (1991),

Akella and Greenbaum (1992), and Song (1994). Yourougou (1990) employs a two factor APT-model, Kwan

(1991), using a random coefficient model, and Song (1994) a two-factor ARCH model. Akella and Greenbaum

(1992) investigated the income sensitivity caused by a repricing mismatch of short term assets and liabilities. In

conclusion, most of the studies for depository institutions in the United States, even when employing different

methodologies, support the notion that returns of bank stocks are more sensitive to changes in interest rates than is

usually captured in the market index. The results of these studies demonstrate that the outcome is quite robust with

respect to the methodology employed.

There are fewer international studies of interest rate risk. Kane, et al does not find interest rate sensitivity

in Japanese city banks, while Bessler and Booth (1994) found that German universal banks were similarly exposed

to interest rate risk compared to U.S. money center banks. Madura and Zarruk (1995) found that banks in Canada,

Japan, Germany and Great Britain are more sensitive to changes in long-term interest rates than US banks. Wagster

(1996) found sensitivity to long term rates for banks in Canada, Germany, Japan, the Netherlands, Switzerland, and

the U.S., while short-term rates are important in Canadian banks.

Empirical studies regarding the existence of exchange rate sensitivity are fewer and the results less

conclusive. Grammatikos, Saunders and Swary (1986) found that while US money center banks do not hold optimal

foreign exchange portfolios, the additional risks are small and adequately covered by bank capital. In two studies,

Jorion (1990, 1991) found little evidence of exchange rate exposure. Also, Kane, et.al, (1990) did not find exchange
rate sensitivity in a sample of Japanese city banks. In contrast, Bodnar and Gentry (1993) and Choi and Prasad

(1995) did find indications of exchange rate exposure, although Choi and Prasad indicated that individual firm risks

may cancel each other out when industry indexes are tested. Choi, Elyasiani and Kopecky (1992) and Wetmore &

Brick (1994) studied the effect of exchange rates on bank stock returns. Both found some evidence of exchange rate

risk in banks and both indicate that the exchange rate risk vary over time. Wetmore & Brick indicated that declines

in interest rate risk seem to be accompanied by increases in exchange rate risk.

III. METHODOLOGY AND DATA

a. Methodology

A multi-index model similar to that of Choi (1992) is estimated for each of the indices by country. The

model is:

Rit = α it + β mt Rmt + β rt Rrt + β ft R ft + ε it

where
Rit = the return on stock index i at time t
Rmt = the return on the national market index at time t
Rrt = the return on an interest rate index at time t; and
Rft = the return on a foreign exchange index at time t.

Using the equation above, ordinary least squares regressions were run for the national industry indexes as

dependent variables. The results of two different multifactor models are shown below. The first model uses the

national market index, the one-year bond index and the national exchange rate index. The second model uses a long-

term bond index in place of the one-year index.

b. Data

The data used for this study was obtained through Datastream International. Datastream maintains many

country-specific indexes for various segments of national economies and financial markets. In this study, we used

monthly returns calculated from the Datastream total market return index and twelve national industry indexes for

Canada, Japan, Germany, UK and the United States. The complete list of variable definitions is shown in Appendix

A. The period covered in this study is January 1985 through December 2002.

All dependent and independent variables are expressed in monthly return form. Specifically, we employ

monthly returns for each of the national industry indexes, monthly returns for an investment in a portfolio of short-

term (1-3 years) or long-term (10+ years) bonds as well as monthly returns for a trade-weighted index of exchange

rates.

The bond returns are derived from monthly observations (January 1985 through December 2002) for the

Datastream Government Bond Tracker index for issues with lives 1-3 years and, separately, for issues with lives

more than 10 years. These returns were used as a measure of short-term (1-3 years) and long-term (10+ years)

interest rates in each country. The returns for exchange rates were calculated from monthly Bank of England

observations for a trade-weighted exchange rate index denominated in the national currency. The only exception is

Germany, which uses the BBI exchange rate index denominated in US dollars.

IV. RESULTS
The results are shown below with a narrative discussion by country. As expected, the return on the total market

index is statistically significant in each model, for each index. In general, the financial indexes exhibit more

instances of interest rate and exchange rate sensitivity than the non-financial indexes.

Table 1: Summary results

Interest Rate Risk Exchange Rate Risk
Financial Non-Financial Financial Non-Financial
Canada 2/3 2/9 1/3 0/9
Germany 2/3 3/8 1/3 3/8
Japan 2/3 3/8 2/3 3/8
United Kingdom 0/3 4/8 0/3 2/8
United States 3/3 4/9 3/3 0/9
Total 9 / 15 16 / 42 7 / 15 8 / 42

Results by country

Canada
Table 2: Market, interest rate and exchange rate coefficients for Canadian indexes
Canada, Monthly Data, Jan 1985 - Dec 2002
Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Financial Indexes
TOTLF 0.8417 ** 0.9746 ** -0.0655 0.8197 ** 0.3684 ** 0.0184
BANKS 0.8471 ** 1.2416 ** 0.0207 0.8192 ** 0.4691 ** 0.1277
INSUR 0.8750 ** 0.4921 -0.6527 * 0.8577 ** 0.2542 -0.6271 *
Non-financial Indexes
BASIC 1.0030 ** -0.8537 ** 0.2022 1.0227 ** -0.3282 ** 0.1300
DIVIN 1.0334 ** 0.7773 -0.5230 1.0320 ** 0.1187 -0.4132
ENGEN 1.0619 ** -0.0386 0.1010 1.0685 ** -0.0774 0.1131
GENIN 1.2597 ** -0.0647 0.1293 1.2620 ** -0.0340 0.1261
PHARM 1.1683 ** -0.4377 -0.4916 1.2203 ** -0.3958 -0.5068
RTAIL 0.7581 ** 0.1486 0.3108 0.7565 ** 0.0370 0.3283
TRNSP 1.0675 ** 0.7790 -0.1825 1.0486 ** 0.3097 -0.1192
UTILS 0.2864 ** 1.1979 ** -0.1505 0.2679 ** 0.3609 ** -0.0249

The results for the Canada highlight the differences in interest rate and exchange rate sensitivity between the

financial and non-financial indexes. Of the financial indexes, the banks (BANKS) and the total financial index

(TOTLF) have positive and significant coefficients for both the short-term and long-term interest rate measures. The

insurance index (INSUR) has a negative, significant coefficient for exchange rates when paired with the long-term

interest rate measure. Of the non-financial indexes, the utilities index (UTILS) also has a positive coefficient for

interest rates, but the basic industries index (BASICA) exhibits a negative coefficient

Germany
Table 3: Market, interest rate and exchange rate coefficients for German indexes
Germany, Monthly Data, Jan 1985 - Dec 2002
Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Financial Indexes
TOTLF 1.1231 ** 0.9047 * -0.1256 1.0693 ** 0.2596 ** -0.1127
BANKS 1.1004 ** 0.4672 -0.2032 * 1.0320 ** 0.1413 -0.1563
INSUR 1.1972 ** 1.2811 * -0.0763 1.1234 ** 0.3887 ** -0.0644
Non-financial Indexes
BASIC 0.8208 ** -0.2177 0.1245 0.8286 ** -0.0573 0.1399
DIVIN 0.6584 ** 1.1774 * 0.0072 0.6282 ** 0.2730 * 0.0751
ENGEN 0.9204 ** -1.1677 * 0.1755 * 0.9508 ** -0.2615 * 0.1430
GENIN 0.9698 ** -0.3626 0.0325 0.9892 ** -0.0760 0.0177
PHARM 0.7113 ** 0.3352 0.2840 ** 0.6913 ** 0.0869 0.2555 *
RTAIL 0.7974 ** 0.8923 -0.2419 0.8808 ** 0.0649 -0.2927 *
TRNSP 0.8299 ** -0.5816 0.2550 0.9201 ** -0.1481 0.1660
UTILS 0.2433 ** 0.4599 -0.1531 * 0.2339 ** 0.1809 * -0.1266

The total financial index, insurance index, diversified industries and engineering/machinery indexes exhibit interest

rate sensitivity for both the short term interest rate and long term interest rate measures. The utilities index shows

sensitivity to long-term rates, but not to short-term rates. For the exchange rates, only the pharmaceutical index

shows significant coefficients when paired with the short term or long-term interest rates. The banks,

engineering/machinery index and utilities display sensitivity to the exchange rate measure when paired with the

short-term interest rate. The retail index only shows significant exchange rate coefficients in the long-term interest

rate model.

Japan
Table 4: Market, interest rate and exchange rate coefficients for Japanese indexes
Japan, Monthly Data, Jan 1985 - Dec 2002
Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Financial Indexes
TOTLF 1.1388 ** 1.2840 * 0.2288 * 1.0686 ** 0.1360 0.2729 **
BANKS 0.9810 ** 1.2780 0.2784 * 0.9376 ** 0.1290 0.3587 **
INSUR 0.9452 ** 1.4800 * 0.1771 0.8598 ** 0.3188 * 0.1749
Non-financial indexes
BASIC 0.9886 ** 0.0645 0.0473 1.0038 ** -0.0623 0.0510
DIVIN 0.7445 ** -0.4198 -0.3480 * 0.8424 ** -0.1879 -0.3237 *
ENGEN 1.0625 ** -0.8526 -0.0915 1.1175 ** -0.1191 -0.0973
GENIN 0.9449 ** -2.0307 ** -0.2789 ** 1.0176 ** -0.3251 ** -0.2738 **
PHARM 0.6911 ** 0.4357 -0.1501 0.6891 ** 0.0003 -0.0860
RTAIL 0.8858 ** -0.3261 0.0562 0.9206 ** -0.0294 0.0282
TRNSP 0.8405 ** 1.5481 ** 0.1223 0.7988 ** 0.2425 * 0.0527
UTILS 0.6560 ** 3.2020 ** 0.2932 * 0.6307 ** 0.5965 ** 0.1284

The Japanese financial index and bank index have significant positive coefficients for the exchange rate variable in

both models. These indexes also exhibit significant coefficients for sensitivity to changes in the short-term interest

rate measure. The insurance index shows sensitivity to both interest rate measures, but not to the exchange rates. In

the non-financial indexes, the general industrials, transportation index and utilities each are sensitive to short-term
and long-term rates. Diversified industries and general industrials exhibit sensitivity to the exchange rate measure

when paired with either the short-term or long-term rates, while the utilities index shows exchange rate sensitivity

only when paired with the short-term rate.

United Kingdom
Table 5: Market, interest rate and exchange rate coefficients for UK indexes
UK, Monthly Data, Jan 1985 – Dec 2002
Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Financial Indexes
TOTLF 1.1041 ** 0.2844 -0.1369 1.1064 ** 0.0554 -0.1449
BANKS 1.1625 ** 0.3522 -0.2418 1.1636 ** 0.0791 -0.2544
INSUR 1.2119 ** 0.5895 -0.1731 1.2190 ** 0.1003 -0.1860
Non-financial indexes
BASIC 1.0707 ** -0.3580 -0.2320 * 1.0858 ** -0.1807 * -0.1939
DIVIN 0.9460 ** -0.3036 -0.0176 0.9915 ** -0.3551 0.0657
ENGEN 1.2360 ** -0.4953 -0.2082 1.2617 ** -0.2800 * -0.1480
GENIN 1.1430 ** -0.5022 -0.0787 1.1493 ** -0.1619 -0.0484
PHARM 0.8475 ** 0.0244 -0.2366 0.8387 ** 0.0601 -0.2513
RTAIL 0.8534 ** 1.2107 ** 0.2677 * 0.8472 ** 0.3350 ** 0.2086
TRNSP 0.9640 ** 0.0147 -0.1778 0.9617 ** 0.0175 -0.1819
UTILS 0.6527 ** 1.1145 ** 0.2428 0.6056 ** 0.6009 ** 0.1249

Interestingly, none of the British financials have significant coefficients for interest rate or exchange rate risk. This

finding is inconsistent with the behavior of the financials in each of the other countries studied. For the non-

financial indexes, retail and utilities have significant coefficients for both the short-term and long-term interest rate

measures. The basic industries and engineering/machinery indexes only show sensitivity to changes in the long-term

interest rates. Only the basic industries and retail indexes show sensitivity to the exchange rate measure.

United States
Table 6: Market, interest rate and exchange rate coefficients for US indexes
US, Monthly Data, Jan 1985 – Dec 2002
Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Financial Indexes
TOTLF 0.9826 ** 1.3949 ** 0.3412 ** 0.9569 ** 0.2800 ** 0.3220 **
BANKS 0.9755 ** 1.1610 * 0.3550 ** 0.9548 ** 0.2269 * 0.3379 **
INSUR 0.7565 ** 1.8685 ** 0.3669 ** 0.7210 ** 0.3842 ** 0.3429 **
Non-financial Indexes
BASIC 0.9720 ** -0.7891 -0.0644 0.9776 ** -0.0778 -0.0388
DIVIN 0.9559 ** -0.5729 -0.1274 0.9595 ** -0.0522 -0.1080
ENGEN 1.0678 ** -1.4429 * -0.0399 1.0842 ** -0.1976 -0.0032
GENIN 1.0666 ** -0.6827 * 0.0295 1.0767 ** -0.1153 * 0.0429
PHARM 0.8441 ** 0.9380 -0.0339 0.8211 ** 0.2402 * -0.0373
RTAIL 1.1894 ** -0.4859 0.2003 1.2003 ** -0.1149 0.2038
TRNSP 0.9460 ** -0.1726 0.2149 0.9461 ** -0.0067 0.2224
UTILS 0.3958 ** 1.9885 ** 0.1060 0.3469 ** 0.5095 ** 0.0989

The US financials show the strongest significant results for sensitivity to both interest rates and exchange rates. The

total financial, banks, and insurance indexes each have significant coefficients for short-term interest rates, long-

term interest rates and exchange rates paired with each. In contrast, none of the non-financials have significant

coefficients for the exchange rate measure. The engineering/machinery, general industrial, and utilities indexes

display sensitivity to the short-term interest rate measure. Long-term interest rate sensitivity is seen in the general

industrial, pharmaceuticals, and utilities indexes.

Results by index

Financial indexes
Table 7: Market, interest rate and exchange rate coefficients for financial indexes across countries
Financial Indexes, Monthly Data, Jan 1985 - Dec 2002
Country Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Canada TOTLF 0.8417 ** 0.9746 ** -0.0655 0.8197 ** 0.3684 ** 0.0184
Germany TOTLF 1.1231 ** 0.9047 * -0.1256 1.0693 ** 0.2596 ** -0.1127
Japan TOTLF 1.1388 ** 1.2840 * 0.2288 * 1.0686 ** 0.1360 0.2729 **
UK TOTLF 1.1041 ** 0.2844 -0.1369 1.1064 ** 0.0554 -0.1449
US TOTLF 0.9826 ** 1.3949 ** 0.3412 ** 0.9569 ** 0.2800 ** 0.3220 **
Canada BANKS 0.8471 ** 1.2416 ** 0.0207 0.8192 ** 0.4691 ** 0.1277
Germany BANKS 1.1004 ** 0.4672 -0.2032 * 1.0320 ** 0.1413 -0.1563
Japan BANKS 0.9810 ** 1.2780 0.2784 * 0.9376 ** 0.1290 0.3587 **
UK BANKS 1.1625 ** 0.3522 -0.2418 1.1636 ** 0.0791 -0.2544
US BANKS 0.9755 ** 1.1610 * 0.3550 ** 0.9548 ** 0.2269 * 0.3379 **
Canada INSUR 0.8750 ** 0.4921 -0.6527 * 0.8577 ** 0.2542 -0.6271 *
Germany INSUR 1.1972 ** 1.2811 * -0.0763 1.1234 ** 0.3887 ** -0.0644
Japan INSUR 0.9452 ** 1.4800 * 0.1771 0.8598 ** 0.3188 * 0.1749
UK INSUR 1.2119 ** 0.5895 -0.1731 1.2190 ** 0.1003 -0.1860
US INSUR 0.7565 ** 1.8685 ** 0.3669 ** 0.7210 ** 0.3842 ** 0.3429 **

One of the objectives of this study is to investigate the consistency of interest rate and/or exchange rate sensitivity

across different countries. The total financial indexes demonstrate this consistent effect. Coefficients for the short-

term interest rate are significant in four of the five countries, with values ranging from 0.9047 (Germany) to 1.3949
(US). Three of five are significant for the long-term interest rate, again with coefficients with consistent size and

sign. Similar results are shown for the banks and insurance indexes. Significant results for the exchange rate

measure are less evident.

For the insurance indexes, Canada and the US show significant coefficients for the exchange rate measure, however

the sign of the coefficient changes from –0.6527 (Canada) to +0.3669 (US). The bank indexes show a similar effect

with Germany having a negative coefficient (-0.2032); Japan and the US have significant, positive coefficients.

Non-financial indexes
Table 8: Market, interest rate and exchange rate coefficients for Non-financial indexes across counties
Non-financial Indexes, Monthly Data, Jan 1985 - Dec 2002
Country Index Mkt4 STIR4 ER4 Mkt5 LTIR5 ER5
Canada BASIC 1.0030 ** -0.8537 ** 0.2022 1.0227 ** -0.3282 ** 0.1300
Germany BASIC 0.8208 ** -0.2177 0.1245 0.8286 ** -0.0573 0.1399
Japan BASIC 0.9886 ** 0.0645 0.0473 1.0038 ** -0.0623 0.0510
UK BASIC 1.0707 ** -0.3580 -0.2320 * 1.0858 ** -0.1807 * -0.1939
US BASIC 0.9720 ** -0.7891 -0.0644 0.9776 ** -0.0778 -0.0388
Canada DIVIN 1.0334 ** 0.7773 -0.5230 1.0320 ** 0.1187 -0.4132
Germany DIVIN 0.6584 ** 1.1774 * 0.0072 0.6282 ** 0.2730 * 0.0751
Japan DIVIN 0.7445 ** -0.4198 -0.3480 * 0.8424 ** -0.1879 -0.3237 *
UK DIVIN 0.9460 ** -0.3036 -0.0176 0.9915 ** -0.3551 0.0657
US DIVIN 0.9559 ** -0.5729 -0.1274 0.9595 ** -0.0522 -0.1080
Canada ENGEN 1.0619 ** -0.0386 0.1010 1.0685 ** -0.0774 0.1131
Germany ENGEN 0.9204 ** -1.1677 * 0.1755 * 0.9508 ** -0.2615 * 0.1430
Japan ENGEN 1.0625 ** -0.8526 -0.0915 1.1175 ** -0.1191 -0.0973
UK ENGEN 1.2360 ** -0.4953 -0.2082 1.2617 ** -0.2800 * -0.1480
US ENGEN 1.0678 ** -1.4429 * -0.0399 1.0842 ** -0.1976 -0.0032
Canada GENIN 1.2597 ** -0.0647 0.1293 1.2620 ** -0.0340 0.1261
Germany GENIN 0.9698 ** -0.3626 0.0325 0.9892 ** -0.0760 0.0177
Japan GENIN 0.9449 ** -2.0307 ** -0.2789 ** 1.0176 ** -0.3251 ** -0.2738 **
UK GENIN 1.1430 ** -0.5022 -0.0787 1.1493 ** -0.1619 -0.0484
US GENIN 1.0666 ** -0.6827 * 0.0295 1.0767 ** -0.1153 * 0.0429
Canada PHARM 1.1683 ** -0.4377 -0.4916 1.2203 ** -0.3958 -0.5068
Germany PHARM 0.7113 ** 0.3352 0.2840 ** 0.6913 ** 0.0869 0.2555 *
Japan PHARM 0.6911 ** 0.4357 -0.1501 0.6891 ** 0.0003 -0.0860
UK PHARM 0.8475 ** 0.0244 -0.2366 0.8387 ** 0.0601 -0.2513
US PHARM 0.8441 ** 0.9380 -0.0339 0.8211 ** 0.2402 * -0.0373
Canada RTAIL 0.7581 ** 0.1486 0.3108 0.7565 ** 0.0370 0.3283
Germany RTAIL 0.7974 ** 0.8923 -0.2419 0.8808 ** 0.0649 -0.2927 *
Japan RTAIL 0.8858 ** -0.3261 0.0562 0.9206 ** -0.0294 0.0282
UK RTAIL 0.8534 ** 1.2107 ** 0.2677 * 0.8472 ** 0.3350 ** 0.2086
US RTAIL 1.1894 ** -0.4859 0.2003 1.2003 ** -0.1149 0.2038
Canada TRNSP 1.0675 ** 0.7790 -0.1825 1.0486 ** 0.3097 -0.1192
Germany TRNSP 0.8299 ** -0.5816 0.2550 0.9201 ** -0.1481 0.1660
Japan TRNSP 0.8405 ** 1.5481 ** 0.1223 0.7988 ** 0.2425 * 0.0527
UK TRNSP 0.9640 ** 0.0147 -0.1778 0.9617 ** 0.0175 -0.1819
US TRNSP 0.9460 ** -0.1726 0.2149 0.9461 ** -0.0067 0.2224
Canada UTILS 0.2864 ** 1.1979 ** -0.1505 0.2679 ** 0.3609 ** -0.0249
Germany UTILS 0.2433 ** 0.4599 -0.1531 * 0.2339 ** 0.1809 * -0.1266
Japan UTILS 0.6560 ** 3.2020 ** 0.2932 * 0.6307 ** 0.5965 ** 0.1284
UK UTILS 0.6527 ** 1.1145 ** 0.2428 0.6056 ** 0.6009 ** 0.1249
US UTILS 0.3958 ** 1.9885 ** 0.1060 0.3469 ** 0.5095 ** 0.0989

Evidence of interest rate and exchange rate sensitivity is less evident in the non-financial indexes, with one notable

exception. The utilities indexes show positive and significant coefficients in all five countries for the long-term

interest rate measure and in four of five countries for the short-term interest rates. Only the German and Japanese

utilities indexes have significant coefficients for the exchange rate measure. For the basic industries index, Canada

has negative, significant coefficients for both the short-term and long-term interest rates; UK only for the long-term

rate. The UK basic industries index is the only one that exhibits significant sensitivity to the exchange rate measure.

For the diversified industries, the German index displays sensitivity to both the short-term and long-term interest

rate measures while the Japanese index is sensitive to the exchange rate measure (both models). The German

engineering/machinery index shows significant coefficients for short-term and long-term interest rates and the

exchange rate measure when paired with the short-term rates. The long-term interest rate coefficient is significant

for the UK index and the short-term interest rate coefficient is significant for the US index. The size and sign

(negative) are consistent for these coefficients across each of these countries. The Japanese general industrial index

exhibits sensitivity to interest rates and exchange rates in both models. The US general industrial index is sensitive

to both long-term and short-term interest rates. For the pharmaceutical index, Germany shows sensitivity to the

exchange rate measure and the US index has a significant coefficient for the long-term interest rate measure. The

German retail index is sensitive to the exchange rate measure when paired with the long-term interest rate. The UK

retail index exhibits significant coefficients for the interest rate measures. Japan is the only country with significant

interest rate coefficients for the transportation index.

V. CONCLUSIONS
This paper extends the previous research on interest rate and exchange rate sensitivity of bank stock returns and

provides some evidence that banks are special. The results indicate that national bank indexes in several countries

show sensitivity to changes in short-term and/or long-term interest rates and exchange rates above the level that is

captured in the total market index. In contrast, most non-financial indexes do not show the same sensitivity. Our

investigation indicates that the sensitivity to interest rates extends to a more general financial index and, in some

countries to the utilities index. Using more specific industry index definitions does not, however, indicate interest

rate sensitivity in the non-financial indexes. A logical extension of this work is to examine interest rate and

exchange rate sensitivity at the individual firm level for several of these countries and indices.
Appendix A

Variable definitions for national industry indexes, interest rates, and exchange rates
NATIONAL INDUSTRY INDEXES AND TOTAL MARKET INDEX
Code Datastream International Total Return Index
BANKS BANKS
TOTLF FINANCIALS
INSUR INSURANCE
BASIC BASIC INDUSTRIES
DIVIN DIVERSIFIED INDS
ENGEN ENG.&MACHINERY
GENIN GEN. INDUSTRIALS
PHARM PHARM. & BIOTECH
RTAIL RETAIL, GENERAL
TRNSP TRANSPORT
UTILS UTILITIES
TOTMK MARKET

SHORT-TERM INTEREST RATE VARIABLES

(DS GOVERNMENT CLEAN PRICE INDEX)
TCNGVG1 CN TRACKER 1-3 YEARS
TBDGVG1 BD TRACKER 1-3 YEARS
TJPGVG1 JP TRACKER 1-3 YEARS
TUKGVG1 UK TRACKER 1-3 YEARS
TUSGVG1 US TRACKER 1-3 YEARS

LONG-TERM INTEREST RATE VARIABLES

(DS GOVERNMENT CLEAN PRICE INDEX)
TCNGVG5 CN TRACKER OVER 10Y
TBDGVG5 BD TRACKER OVER 10Y
TJPGVG5 JP TRACKER OVER 10Y
TUKGVG5 UK TRACKER OVER 10Y
TUSGVG5 US TRACKER OVER 10Y

EXCHANGE RATE VARIABLES Currency

BOECAN$ CANADIAN $ INDEX 1990=100 (BOE) - TRADE WEIGHTED C$
BOEJAPY JAPANESE YEN INDEX 1990=100 (BOE) - TRADE Y
WEIGHTED
BOESTER UK £ INDEX 1990=100 (BOE) - TRADE WEIGHTED £
BOEUSA$ US $ INDEX 1990=100 (BOE) - TRADE WEIGHTED U$
BBDEMSP GERMAN MARK TO US $ (BBI) - EXCHANGE RATE U$
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