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Optimal diversification, bank value maximization and default probability

Author

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  • Yung-Shun Tsai
  • Chien-Chih Lin
  • Hsiao-Yin Chen

Abstract

This study argues that the optimal level of diversification for the maximization of bank value is asymmetrical and depends on the business cycle. During times of expansion, systematic risks are relatively low; hence, the effect of raising systematic risks from portfolio diversification is slight. Consequently, the benefit of reducing individual risks dominates any loss from raising systematic risks, leading to a higher value for a bank by holding a diversified portfolio of assets. On the contrary, during times of recession, systematic risks are relatively high. It is more likely that the loss from raising systematic risks surpasses the benefit of reducing individual risks from portfolio diversification. Consequently, more diversification leads to lower bank values. Finally, some empirical evidence from the banks in Taiwan is provided.

Suggested Citation

  • Yung-Shun Tsai & Chien-Chih Lin & Hsiao-Yin Chen, 2015. "Optimal diversification, bank value maximization and default probability," Applied Economics, Taylor & Francis Journals, vol. 47(24), pages 2488-2499, May.
    • Handle: RePEc:taf:applec:v:47:y:2015:i:24:p:2488-2499
    DOI: 10.1080/00036846.2015.1008766
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    Citations

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    Cited by:

    1. Jonathan A. Batten & Xuan Vinh Vo, 2016. "Bank risk shifting and diversification in an emerging market," Risk Management, Palgrave Macmillan, vol. 18(4), pages 217-235, December.
    2. Jorge Andrés Munoz Mendoza & Sandra María Sepúlveda-Yelpo & Carmen Lissette Veloso-Ramos & Carlos Leandro Delgado-Fuentealba, 2020. "Market Concentration and Income Diversification: Do They Always Promote the Financial Stability of Banking Industry?," Revista Finanzas y Politica Economica, Universidad Católica de Colombia, vol. 12(2), pages 341-365, August.
    3. Ersan Ersoy & Beata Swiecka & Simon Grima & Ercan Özen & Inna Romanova, 2022. "The Impact of ESG Scores on Bank Market Value? Evidence from the U.S. Banking Industry," Sustainability, MDPI, vol. 14(15), pages 1-14, August.
    4. Minzhi Wu & Emili Tortosa-Ausina & Paula Cruz-García, 2024. "The impact of diversification on the profitability and risk of Chinese banks: evidence from a semiparametric approach," Empirical Economics, Springer, vol. 67(6), pages 2565-2606, December.
    5. Minzhi Wu & Emili Tortosa-Ausina, 2020. "Bank Diversification and Focus in Disruptive Times: China, 2007–2018," Working Papers 2020/21, Economics Department, Universitat Jaume I, Castellón (Spain).
    6. Kim, Hakkon & Batten, Jonathan A. & Ryu, Doojin, 2020. "Financial crisis, bank diversification, and financial stability: OECD countries," International Review of Economics & Finance, Elsevier, vol. 65(C), pages 94-104.
    7. Maghyereh, Aktham Issa & Yamani, Ehab, 2022. "Does bank income diversification affect systemic risk: New evidence from dual banking systems," Finance Research Letters, Elsevier, vol. 47(PB).
    8. Haykel Zouaoui & Faten Zoghlami, 2023. "What do we know about the impact of income diversification on bank performance? A systematic literature review," Journal of Banking Regulation, Palgrave Macmillan, vol. 24(3), pages 286-309, September.

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