The Sensitivity of Bank Stock Returns to Real Estate Risks: The Case of the US

Abstract

The purpose of this paper is to investigate the effect of real estate returns and their volatility on the generation process of US bank stock returns. The approach employs the generalized autoregressive conditionally heteroskedastic in the mean (GARCH-M)model to account for the ARCH effects in daily returns. Most prior studies used OLS and EGARCH to estimate the sensitivity of US bank stocks. However, because ARCH- and GARCH effects are found to be significant, the OLS method may generate inefficient results. In our paper we compare the results generated by OLS and GARCH models. Apart from the traditional volatility equation, we introduce a dummy variable to examine the change in risk before and after the financial crisis. The findings show that real estate returns and their volatility impact US bank stock returns and US bank return volatility directly, and that the impact is more sensitive after the global financial crisis. The occurrence of the global financial crisis shifts US banks’ return volatility upward. In addition, most of the individual banks and portfolios exhibit a substantial degree of persistence in shocks. The findings above are important for investors who seek to predict the performance of bank stocks. In summary, our paper adds a real estate return factor into the traditional three-index model and show sthat ARCH and GARCH effects do affect the measures of sensitivity and volatility.