Does the Stock Market Value Bank Diversification?

29 Pages Posted: 22 Feb 2006  

Lieven Baele

Tilburg University - Department of Finance

Olivier De Jonghe

Tilburg University - Department of Finance; Tilburg University - European Banking Center

Rudi Vander Vennet

Ghent University-Universiteit Gent - Department of Financial Economics

Multiple version iconThere are 2 versions of this paper

Date Written: August 10, 2006

Abstract

This paper investigates whether or not functionally diversified banks have a comparative advantage in terms of long-term performance/risk profile compared to their specialized competitors. To that end, this study uses market-based measures of return potential and bank risk. We calculate the franchise value over time of European banks as a measure of their long-run performance potential. In addition, we measure risk as both the systematic and the idiosyncratic risk sensitivities derived from a bank stock return model. Finally, we analyze the return/risk trade-off implied in different functional diversification strategies using a panel data analysis over the period 1989-2004. A higher share of non-interest income in total income affects banks' franchise values positively. Diversification of revenue streams from distinct financial activities increases the systematic risk of banks while the effect on the idiosyncratic risk component is non-linear and predominantly downward-sloping. These findings have conflicting implications for different stakeholders, such as investors, bank shareholders, bank managers and bank supervisors.

Keywords: Second Banking Directive, diversification, bank stock returns, charter value, risk factors

JEL Classification: G21, G28, L25

Suggested Citation

Baele, Lieven and De Jonghe, Olivier and Vander Vennet, Rudi, Does the Stock Market Value Bank Diversification? (August 10, 2006). Available at SSRN: https://ssrn.com/abstract=883593 or http://dx.doi.org/10.2139/ssrn.883593

Lieven Baele

Tilburg University - Department of Finance ( email )

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

Olivier De Jonghe (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
0031-13-466.2650 (Phone)

Tilburg University - European Banking Center ( email )

PO Box 90153
Tilburg, 5000 LE
Netherlands

Rudi Vander Vennet

Ghent University-Universiteit Gent - Department of Financial Economics ( email )

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

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