As this brief review indicates, prior studies have examined the impact of both
short-term and long-term interest rates on bank stocks. Most of these studies use
BANK EXPOSURE TO INTEREST RATE RISKS DURING FINANCIAL LIBERALIZATION 67
a two-factor asset pricing model with bank equity returns as the dependent variable
and returns on a market index as one of the independent factors and the
unanticipated changes in an interest rate as the second factor. As an econometric
innovation, recent studies have replaced unanticipated interest rate changes as
the second independent variable by its unsystematic component, i.e., the residuals
from a regression between the unanticipated interest rate and the market index,
the first independent variable. In addition, some studies have also used a three
factor model with the anticipated changes in interest rates as the additional independent
variable (e.g., Bae, 1990). As discussed above, financial regulations in
Korea have acted as more significant constraints on Korean banks than is the case
in developed countries like the United States. Thus, this third factor, anticipated
interest rates, can be expected to be important for Korean banks during periods
of government control. Also, as discussed above, the interest rate sensitivity of
Korean banks is expected to change with changes in the regulatory and financial
environment.