Does the Stock Market Value Bank Diversification?

Posted: 21 Sep 2006 Last revised: 27 Jan 2008

See all articles by Olivier De Jonghe

Olivier De Jonghe

Tilburg University - Department of Finance; National Bank of Belgium - Research Department; Tilburg University - European Banking Center

Lieven Baele

Tilburg University - Department of Finance

Rudi Vander Vennet

Ghent University - Department of Financial Economics

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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

De Jonghe, Olivier and De Jonghe, Olivier and Baele, Lieven and Vander Vennet, Rudi, Does the Stock Market Value Bank Diversification?. Journal of Banking & Finance, Vol. 31, No. 7, pp. 1999-2023, July 2007, Available at SSRN: https://ssrn.com/abstract=931876

Olivier De Jonghe (Contact Author)

Tilburg University - Department of Finance ( email )

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

National Bank of Belgium - Research Department ( email )

Research Department
Boulevard de Berlaimont 14
B-1000 Brussels, 1000
Belgium

Tilburg University - European Banking Center ( email )

PO Box 90153
Tilburg, 5000 LE
Netherlands

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)

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)

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