Interest rate risk and the creation of the Monetary Policy Committee: Evidence from banks' and life insurance companies' stocks in the UK

Abstract

This paper investigates the effect that the creation of the Monetary Policy Committee (MPC) has had on the interest rate risk which banks and life insurance companies face in the UK. By means of GARCH-M methodology, the stock returns are modelled on the CAPM and the Fama-French asset-pricing models, augmented with interest rate risk factors and referring to short- and long-term rates. Our results indicate that in the period before the Bank of England (BoE) was granted operational independence, changes in the level and volatility of interest rates significantly affected the stock returns of these companies. These effects have diminished since the MPC's creation in May 1997. In parallel, since the MPC's creation, macroeconomic uncertainty, as proxied by the MPC dissents, coexisted with significant effects on the short-term interest rate risk which banks and life insurance companies face. These results should be of interest to both analysts and policy-makers with respect to financial stability. © 2013 Elsevier Inc.