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This paper examines the spill-over effects of interest rate risk and return on Australian and US financial firms using a dynamic conditional correlation GARCH model. Australian banks exhibit negative exposure to changes in both domestic and US interest rates, and US interest rate volatility is found to be an important predictor of Australian bank stock return volatility. Similar findings are obtained for the aggregate portfolio of financial stocks. The time-varying conditional correlation between Australian and US financial stock returns increases during financial crises and varies directly with net capital flows between Australia and the US. Further, the conditional correlation increases (decreases) during the contractionary (expansionary) periods of the US business cycle.

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