Paper: arXiv 2510.07671

Authors: Matt Brigida

Abstract

Research has shown banks match interest income and expense betas, and thereby obtain net interest income margins which are insensitive to changes in short-term interest rates. The present analysis extends this research in a number of ways. First, we use state-space methods to estimate time-varying betas and test whether they are matched at each time interval. We find substantial variation in interest income and expense betas, which drives variation in net interest margin beta coefficients. Second, we estimate the time-varying conditional volatility of beta forecasts the uncertainty of future beta values. We find uncertainty in interest expense beta coefficients drives uncertainty in interest income betas. Further, large banks have greater expense beta uncertainty, whereas small banks have greater income beta uncertainty. Lastly, we find evidence that uncertainty in interest expense betas is priced by the market, and is negatively related to bank stock prices. This is a new and previously unmeasured source of unhedgeable risk in bank stocks, and highlights an additional benefit of the Federal Reserve’s Zero Interest Rate Policy.

Complexity vs Empirical Score

  • Math Complexity: 5.5/10
  • Empirical Rigor: 7.5/10
  • Quadrant: Holy Grail — high math complexity, high empirical rigor

Why this score: The paper provides a strong empirical extension to the literature on bank interest rate risk by implementing state-space methods and Kalman filtering to capture time-varying betas and conditional volatility. It features rigorous statistical testing across bank asset size deciles and introduces novel insights into how interest expense beta uncertainty acts as an unhedgeable risk factor affecting bank equity prices.

Research Flowchart

  flowchart TD
    A[Research Goal: Analyze Time-Varying Bank Betas, Uncertainty, & Asset Pricing] --> B[Data Inputs: Bank Interest Income, Expenses, Short-Term Rates & Stock Prices]
    B --> C[Method 1: State-Space Models to Estimate Time-Varying Income, Expense & NIM Betas]
    B --> D[Method 2: Conditional Volatility Models to Measure Beta Forecast Uncertainty]
    C & D --> E[Asset Pricing Model: Test Market Pricing of Beta Uncertainty on Bank Stocks]
    E --> F[Finding 1: Betas vary significantly over time, driving Net Interest Margin variation]
    E --> G[Finding 2: Large banks face higher Expense Beta uncertainty; Small banks face higher Income Beta uncertainty]
    E --> H[Finding 3: Expense Beta uncertainty is a priced, unhedgeable risk negatively impacting stock prices]

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0 of 42 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.