A Market-Based Risk Classification of Financial Institutions
34 Pages Posted: 17 Dec 1996
Date Written: November 1996
This paper derives, estimates, and analyzes a multi-factor model of the monthly holding period returns on the stocks of exchange-traded financial institutions. In addition to bond and equity returns, the factors include default, liquidity, and term structure risk premiums plus variables that measure changes in deposit demand. To ensure that our sample has a large number of firms, we use data from January 1981 through December 1988. The equity return explains a large share of time-series variation in financial institutions returns. The additional factors implied by banking theory have little incremental explanatory power. The two-factor model regression coefficients have considerable cross-sectional variation. This permits us to group banks into portfolios with similar risk exposures. These portfolios bear no relation to the SIC codes that group banks by their charters and lines of business.
JEL Classification: D81
Suggested Citation: Suggested Citation