Do Lower Returns on Bank Stocks Suggest Lower Cost of Capital? An Explanation for the Low Risk Anomaly and the Loan Growth Effect

50 Pages Posted: 17 Jan 2018

See all articles by Mike Qinghao Mao

Mike Qinghao Mao

Deakin University - Faculty of Business and Law

K.C. John Wei

Hong Kong Polytechnic University

Date Written: January 17, 2018

Abstract

Banks with higher equity risk and faster loan growth have lower abnormal stock returns. By disentangling ex ante cost of capital from cash flow and discount rate news in bank stock returns, we show that the lower returns do not suggest lower cost of capital. The underperformance of banks with higher equity risk is explained by the poorer cash flow news. The underperformance of banks with faster loan growth is due to both the cash flow and the discount rate news components. Overall, the evidence points to the nontrivial role of investors’ inefficient forecasts of expected bank risk and fundamentals.

Keywords: Capital Requirements, Bank Loan Growth, Cash Flow News, Discount Rate News, Cost of Capital

JEL Classification: G12, G14, G21

Suggested Citation

Mao, Mike Qinghao and Wei, Kuo-Chiang (John), Do Lower Returns on Bank Stocks Suggest Lower Cost of Capital? An Explanation for the Low Risk Anomaly and the Loan Growth Effect (January 17, 2018). Available at SSRN: https://ssrn.com/abstract=3103838 or http://dx.doi.org/10.2139/ssrn.3103838

Mike Qinghao Mao (Contact Author)

Deakin University - Faculty of Business and Law ( email )

70 Elgar Road
Burwood, Victoria 3125
Australia
+61392446574 (Phone)

Kuo-Chiang (John) Wei

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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