The Effects of Exchange Rate and Interest Rate Exposure on the Stock Returns and Volatility of Turkish Insurance Companies

Year 2020, Volume: 70 Issue: 1, 141 - 161, 30.06.2020

İsmail Erkan Çelik

https://doi.org/10.26650/ISTJECON2020-0013

Abstract

This study examines the impact of exchange rate and interest changes on stock returns and volatility of Turkish insurance companies using the EGARCH model for the period of 01/01/2009 to 15/04/2020. The results show: (i) while interest rate has a negative and significant effect on the conditional stock return, its effect on the volatility of stock returns of insurance companies is limited; (ii) however, the exact opposite is true for the exchange rate risk. The exchange rate risk exerts an important impact on the volatility of insurance stock returns but it has no effect on the mean stock returns of insurance companies; (iii) the findings also indicate that the volatility of insurance stock returns are highly persistent over time and they are more sensitive to old news than recent surprises; (iv) positive and negative news have an asymmetric effect on volatility implying that positive innovations (good news such as a market) have a larger impact on current conditional variance (current volatility of returns) than negative innovations (bad news such as market stagnation) of the same magnitude; (v) finally, the volatility of insurance portfolio’s and insurance companies’ stock returns has risen significantly during the financial crisis of 2008 compared to the rest of the sample period

Keywords

Volatility, Insurance companies, EGARCH model, Exchange rate risk, Interest rate risk

The Effects of Exchange Rate and Interest Rate Exposure on the Stock Returns and Volatility of Turkish Insurance Companies

Abstract

This study examines the impact of exchange rate and interest changes on stock returns and volatility of Turkish insurance companies using the EGARCH model for the period of 01/01/2009 to 15/04/2020. The results show: (i) while interest rate has a negative and significant effect on the conditional stock return, its effect on the volatility of stock returns of insurance companies is limited; (ii) however, the exact opposite is true for the exchange rate risk. The exchange rate risk exerts an important impact on the volatility of insurance stock returns but it has no effect on the mean stock returns of insurance companies; (iii) the findings also indicate that the volatility of insurance stock returns are highly persistent over time and they are more sensitive to old news than recent surprises; (iv) positive and negative news have an asymmetric effect on volatility implying that positive innovations (good news such as a market) have a larger impact on current conditional variance (current volatility of returns) than negative innovations (bad news such as market stagnation) of the same magnitude; (v) finally, the volatility of insurance portfolio’s and insurance companies’ stock returns has risen significantly during the financial crisis of 2008 compared to the rest of the sample period.

Keywords

Volatility, Insurance companies, EGARCH model,

References

• Mouna, A. & Anis, J. (2016) Market, interest rate, and exchange rate risk effects on financial stock returns during the financial crisis: AGARCH-M approach, Cogent Economics & Finance, 4:1, 1125332, DOI: 10.1080/23322039.2015.1125332.
• Bach, B. & Ando, A. (1957). The redistribution of effects of inflation. The Review of Economics and Statistics, 3, 1–13.
• Bollerslev, T. (1986). Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics, 31, 307-327
• Brewer, E., Carson, J., Elyasiani, E., Mansur, I., & Scott, W. (2007). Interest rate risk and equity values of life insurance companies: A GARCH‐M model. Journal of Risk and Insurance, 74, 401 –423.
• Carson, J. M., Elyasiani, E. & Mansur, I. (2008) Market Risk, Interest Rate Risk, and Interdependencies in Insurer Stock Returns: A System-GARCH Model, Journal of Risk & Insurance, 75(4), 873-891.
• Çelik, İ. E. (2019), Assessing the impact of bank risk factors on Turkish bank’s stock returns using The EGARCH-M model, Üçüncü Sektör Sosyal Ekonomi Dergisi, 54(2), 811-827.
• Chang, C. L., H. K. Hsu & M. McAleer (2014) The impact of China on stock returns and volatility in the Taiwan tourism industry, North American Journal of Economics and Finance, 29, 381–401.
• Çiçek, M. (2014). Türkiye’de faiz, döviz ve borsa: fiyat ve oynaklık yayılma etkileri, Ankara Üniversitesi SBF Dergisi, 65(2), 1-28.
• De Sousa, A. M., Noriller, R. M., Huppes C. M., Vaz Lopes, A. C., Meurer, R. M. (2018). Relation between the macroeconomic variables and the stock return in companies of the finance and insurance sector from Latin American stock market, Revista Journal, Vol.12, N3, 20-30.
• Dickey, D. & Fuller W. (1981). likelihood ratio statistics for autoregressive time series with a unit root, Econometrica, 49, 1057-1072.
• Dikko, H. G., Asiribo, O. E. & Samson, A. (2015). Modelling Abrupt Shift in Time Series Using Indicator Variable: Evidence of Nigerian Insurance Stock, International Journal of Finance and Accounting, 2015, 4(2), 119-130.
• Ekinci, A. (2016). The effect of credit and market risk on bank perforamance: evidence from Turkey, International Journal of Economics and Financial Issues, 6(2), 427-434.
• Elyasiani, E., & Mansur, I. (2005). The association between market and exchange rate risks and accounting variables: A GARCH model of the Japanese banking institutions, Review of Quantitative Finance and Accounting, 25(2), 183–206.
• Elyasiani, E. & Mansur, I., (1998). Sensitivity of bank stock returns distribution to changes in the level of volatility of interest rate: a GARCH-M model, Journal of Banking and Finance, 22, 535–563.
• Enders, Walter (2015). Applied econometrics time series, John Wiley & Sons Inc.
• Engle R. F. & Granger, C. W. J. (1987). Cointegration and error correction: representation, estimation and testing, Econometrica, 50, 987-1007.
• Engle, R. F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation, Econometrica, 50(4), 987-1007.
• Engle, R. F. and Ng, V. & Rothschild, M., (1990). Asset pricing with a factor ARCH covariance structure: Empirical estimates for treasury bills, Journal of Econometrics, 45, 213-238.
• Flannery, M. J., Hameed, A.S. & Harjes, R. H. (1997). Asset pricing, time-varying risk premia and interest rate risk. Journal of Banking & Finance, 21, 315–335.
• Francq, C. & Zakoian, J. M. (2019). GARCH models structure, statistical inference and financial applications, New Jersey: John Wiley & Sons.
• French, K., Ruback, R., & Schwart, G. (1983). Effects of nominal contracting on stock returns, Journal of Political Economy, 91(1), 70–96.
• Hamadu, D. & A. Ibiwoye (2010). Modelling and forecasting the volatility of the daily returns of nigerian insurance stocks, International Business Research, 3(2), 106-116.
• Hooy, C. W., Tan, H. B. & Md Nassir, A. (2004). Risk sensitivity of bank stocks in Malaysia: empirical evidence across the Asian financial crisis, Asian Economic Journal, 18, 261–276.
• Jensen, T.K., Johnson, R. R. & McNamara, M. J. (2019) Funding conditions and insurance stock returns: Do insurance stocks really benefit from rising interest rate regimes?, Risk Management and Insurance Review, 22, 367–391.
• Kasman, S., Vardar, G. & Tunç, G., (2011). The impact of interest rate and exchange rate volatility on bank’s stock returns and volatility: Evidence from Turkey, Economic Modelling, 28, 1328-1334.
• Katusiime, L. (2019). Investigating Spillover Effects between Foreign Exchange Rate Volatility and Commodity Price Volatility in Uganda, Economies 2019, 7, 1, https://www.mdpi.com/journal/economies.
• Kessel, R. (1956). Inflation-caused wealth redistribution: a test of a hypothesis, The American Economic Review, 3, 128–141.
• Mansur, I. & Elyasiani, E. (1995). Sensitivity of bank equity returns to the level and volatility of interest rates, Managerial Finance, 21, 58-77.
• Mechri, N., Ben Hamad, S., Peretti, C., Charf, S. (2018). The Impact of the Exchange Rate Volatilities on Stock Markets Dynamics: Evidence from Tunisia and Turkey, https://ssrn.com/ abstract=3304040 or http://dx.doi.org/10.2139/ssrn.3304040.
• Merton, R. C. (1973). An intertemporal capital asset pricing model, Econometrica, 41, 867–887.
• Nelson, D. B. (1991). Conditional heteroskedasticity in asset returns: A new approach, Econometrica, 59 (2), 347–370.
• Olugbode, M., El-Masry, A. & Pointon, J. (2014). Exchange rate and interest rate exposure of UK industries using first-order autoregressive exponential GARCH-in-Mean (EGARCH-M) approach, The Manchester School, 82(4), 409-464.
• Özçiçek, Ö. (1997). Türkiye’de döviz kuru getirisi ve hisse senedi endeks getirileri oynaklıkları arası simetrik ve asimetrik ilişki, İMKB Dergisi, 10(37), 1-11.
• Papadamou, S. & Siriopoulos, C. (2014). Interest rate risk and the creation of the Monetary Policy Committee: Evidence from banks’ and life insurance companies’ stocks in the UK Journal of Economics and Business, 71 (2014) 45–67.
• Phillips, P. C. B. & Perron, P. (1988). Testing for a unit root in time series regression, Biometrika, 75, 335-346.
• Ryan, S. & Worthington, A. (2004). Market, interest rate and foreign exchange rate risk in Australian banking: a GARCH-M approach, International Journal of Applied Business and Economic Research, 2(2), 81–103.
• Saunders, A. & Yourougou, P. (1990). Are banks special? The separation of banking from commerce and interest rate risk, Journal of Economics and Business, 42, 171–182.
• Sehgal, S. & Agrawal, T. J. (2017). Bank risk factors and changing risk exposures in the pre- and post-financial crisis periods: An empirical study for India, Management and Labour Studies, 42(4), 356-378.
• Yourougou, P. (1990). Interest rate and the pricing of depository financial intermediary common stock: empirical evidence, Journal of Banking & Finance, 14, 803–820.