Risk Overhang and Loan Portfolio Decisions

42 Pages Posted: 23 Aug 2005

See all articles by Robert DeYoung

Robert DeYoung

University of Kansas School of Business

Anne Gron

Northwestern University - Kellogg School of Management

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management; Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Date Written: August 2005

Abstract

Despite operating under substantial regulatory constraints, we find that commercial banks manage their investments largely consistent with the predictions of portfolio choice models with capital market imperfections. Based on 1990-2002 data for small (assets less than $1 billion) U.S. commercial banks, net new lending to the business, real estate, and consumer sectors increased with expected sector profitability, tended to decrease with the illiquidity of existing (overhanging) loan stocks, and was responsive to correlations in cross-sector returns. Small banks are most appropriate for this study, because they make illiquid loans and manage risk via on-balance sheet (non-hedged) diversification strategies.

Keywords: commercial banks, loans, portfolio choice, risk overhang

JEL Classification: G11, G21

Suggested Citation

DeYoung, Robert and Gron, Anne and Winton, Andrew, Risk Overhang and Loan Portfolio Decisions (August 2005). FRB of Chicago Working Paper No. 2005-04. Available at SSRN: https://ssrn.com/abstract=785106 or http://dx.doi.org/10.2139/ssrn.785106

Robert DeYoung (Contact Author)

University of Kansas School of Business ( email )

Summerfield Hall
1300 Sunnyside Avenue
Lawrence, KS 66045
United States
785-864-1806 (Phone)

Anne Gron

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Department of Management and Strategy
Evanston, IL 60208
United States
847-491-8687 (Phone)
847-467-1777 (Fax)

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management ( email )

321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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