Banks' Stockholdings and the Correlation between Bonds and Stocks

: A Portfolio Theoretic Approach

March 25, 2013
Yoshiyuki Fukuda^*1
Kazutoshi Kan^*2
Yoshihiko Sugihara^*3

Abstract

In this paper, we analyze the optimal asset composition ratio of stocks and bonds for a bank taking into consideration the correlation between the interest rate risk and equity risk in the financial capital market using a portfolio model. The analysis reveals that in determining the asset composition ratio in Japan, the correlation coefficient between the interest rate and stock prices as well as the stock price volatility plays a more important role than the interest rate volatility. We also show that in the present circumstances, the stockholding ratios of most financial institutions in Japan are higher than the levels calculated from the model. It is suggested that when the market is exposed to severe stress such as a surge in stock price volatility or reversal of the correlation between the interest rate and stock prices, the stockholding ratios would be even more excessive than the levels obtained from the model.

The authors are grateful to Professor Alistair Milne (U.K. Loughborough University) and the Bank of Japan's staff for their useful comments in the process of developing this paper, and Satomi Misawa and Minako Noutomi for their cooperation in its creation. Any errors are the authors' own. The views expressed here are those of the authors and do not reflect the official views of the Bank of Japan or its Financial System and Bank Examination Department.

*1 International Department (ex-Financial System and Bank Examination Department)
E-mail : yoshiyuki.fukuda@boj.or.jp
*2 Financial System and Bank Examination Department
E-mail : kazutoshi.kan@boj.or.jp
*3 Personnel and Corporate Affairs Department (ex-Financial System and Bank Examination Department)

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