Risk and Market Segmentation in Financial Intermediaries' Returns
96-36
32 Pages Posted: 17 Dec 1996
Date Written: October 1996
Abstract
This study examines both the quantity and price of risk exposure for different segments of financial intermediaries in order to determine whether market segmentation exists in the financial services industry in the United States. We distinguish between depository institutions, securities firms, insurance companies, mutual funds, and other financial firms using each company s SIC code. We find evidence of market segmentation in both market risk levels and market risk premiums. The results provide little evidence of interest rate risk exposure across all types of financial intermediaries, suggesting the prevalence of hedging programs using interest rate derivatives. However, the market prices interest rate risk exposure differentially by type of financial intermediary. We find that as a market segment, insurance companies were exposed to more interest rate risk particularly in the period late 1980 s to early 1990 s. The interest rate risk premium for banks was among the highest of all financial intermediaries. Overall, we find that securities firms, as a group, have the most market risk exposure, followed in order of descending market beta, by banks, other financial firms, insurance companies, and mutual funds, although the order is reversed when examining the market risk premium. Indeed, we find support for an inverse relationship between the quantity and price for market risk, but not for interest rate risk. When we investigate the impact of two regulatory policy changes, we find that (1) the shift in the conduct of monetary policy towards targeting of monetary aggregates induced banks to take on more market risk, probably due to a decline in their charter value; (2) bank market risk-taking increased further with the introduction of riskbased capital requirements which further reduce charter value for banks; and (3) insurance companies are subject to the highest interest rate risk premiums during the 1988-1994 subperiod, following by commercial banks, probably due to interest rate risk subsidy under the risk-based capital requirements. Overall, during the period 1974-1994, banks increased their market risk exposure despite the tightening of regulatory restrictions, insurance companies increased their interest rate risk exposure over the subperiods. We create synthetic universal banks comprised of portfolios of banks, securities firms, and insurance companies. We find that the synthetic universal banks have significantly positive excess returns, with lower market and interest rate risk exposures and higher expected returns than securities firms.
JEL Classification: D81
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Change in Market Assessments of Deposit-Institution Riskiness
By Edward J. Kane and Haluk Unal
-
The Sensitivity of Bank Stock Returns to Market, Interest and Exchange Rate Risks
By Jongmoo Jay Choi, Elyas Elyasiani, ...
-
By Gary B. Gorton and Richard J. Rosen
-
By Elyas Elyasiani and Iqbal Mansur
-
Modeling Structural and Temporal Variation in the Market's Valuation of Banking Firms
By Edward J. Kane and Haluk Unal
-
The Exchange Rate Exposure of U.S. And Japanese Banking Institutions
By Helen Popper, Sandra Chamberlain, ...
-
Derivative Exposure and the Interest Rate and Exchange Rate Risks of U.S. Banks
By Elyas Elyasiani and Jongmoo Jay Choi
-
Asymmetric Information, Dividend Reductions, and Contagion Effects in Bank Stock Returns
By Wolfgang Bessler and Tom Nohel