Interest Rate Risk Rewards in Stock Returns of Financial Corporations: Evidence from Germany

The interest rate sensitivity of the stock returns of financial and non-financial corporations is awell-known phenomenon. However, only little is known about how much of total stockreturns is attributable to the compensation an investor receives for being exposed to interestrate risk when investing in equity securities. We pursue here a benchmark portfolio approach,constructing benchmark portfolios with the same interest rate risk exposure as a particularstock. By studying the time series of returns of these asset-specific benchmarks, we find: i)Regardless of the industry considered, the interest rate risk benchmarks of Germancorporations have mostly earned a significantly positive reward. ii) Returns of interest raterisk benchmarks of financial institutions exceed significantly those of non-financialcorporations. iii) An investor willing to bear nothing but the average interest rate risk ofGerman financial institutions would have earned a mean return of about or even exceeding70% of the corresponding total stock returns. iv) Returns of the interest rate risk benchmarksof the German insurance sector are significantly higher than those of German banks, whichseems to contradict conventional market wisdom that insurances hedge interest rate risks.