Bank Risk Strategies and Cyclical Variation in Bank Stock Returns

Ghent University Economics & Business Working Paper

47 Pages Posted: 25 Mar 2004

See all articles by Lieven Baele

Lieven Baele

Tilburg University - Department of Finance

Rudi Vander Vennet

Ghent University - Department of Financial Economics

Astrid Van Landschoot

Single Resolution Board

Date Written: January 2004

Abstract

This paper investigates whether the stock returns of banks with different risk profiles exhibit different risk factor sensitivities over the business cycle. More specifically, we investigate whether or not high levels of capital adequacy or functional diversification provide banks with a structural hedge against a deterioration in the prevailing credit market conditions. Based on recent imperfect capital market theories, we develop a number of theoretical arguments for the existence of asymmetries in systematic risk across various types of banks. We use a regime-switching model to test the theoretical hypotheses empirically on a sample of European listed banks. We find that bank stock returns are strongly asymmetric; both the sensitivity to shocks and the conditional volatility are higher during business cycle troughs. Better capitalized and functionally diversified banks are perceived by investors as being better protected against a deterioration in credit market conditions compared to their relatively less capitalized and more specialized competitors.

Keywords: Bank Risk, Financial Conglomerates, Capital Adequacy, Regime-Switching Models, Basel II

JEL Classification: G12, G21, F34

Suggested Citation

Baele, Lieven and Vander Vennet, Rudi and Van Landschoot, Astrid, Bank Risk Strategies and Cyclical Variation in Bank Stock Returns (January 2004). Ghent University Economics & Business Working Paper, Available at SSRN: https://ssrn.com/abstract=494303 or http://dx.doi.org/10.2139/ssrn.494303

Lieven Baele (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 3257 (Phone)
+31 13 466 2875 (Fax)

Rudi Vander Vennet

Ghent University - Department of Financial Economics ( email )

Ghent, 9000
Belgium
+32 9 264 35 13 (Phone)
+32 9 264 35 92 (Fax)

Astrid Van Landschoot

Single Resolution Board ( email )

Brussels, 1000

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