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The Effects of Diversification on Banks´ Expected Returns

Author

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  • Dairo Estrada
  • Angela González Arbeláez
  • Javier Gutierréz Rueda

Abstract

In financial theory, the optimal allocation of assets and its relationship withprofitability has been one of the main concerns; the question has always been ifbanks should focus or diversify their assets. In our case, we would like to answerthis question focusing in diversification of the loan portfolio, presenting a theoreticalmodel that considers the possible gains from diversification, while taking intoaccount the effects of monitoring. Additionally, we present empirical evidence onthis matter for the Colombian banking system. According to the model, we findthat once the banks have chosen its optimal level of monitoring, expected return isalways higher when the bank decides to focus. Additionally, the empirical resultssuggest that there are no possible gains form diversification in bank´s cost and that,on average, the effects of focusing the loan portfolio reduces bank´s return whileshowing positive effects of focusing on an specific sector.

Suggested Citation

  • Dairo Estrada & Angela González Arbeláez & Javier Gutierréz Rueda, 2008. "The Effects of Diversification on Banks´ Expected Returns," Borradores de Economia 4991, Banco de la Republica.
    • Handle: RePEc:col:000094:004991
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    References listed on IDEAS

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    Cited by:

    1. David Pérez-Reyna, 2009. "Una aproximación para analizar la estabilidad financiera por medio de un DSGE," Temas de Estabilidad Financiera 040, Banco de la Republica de Colombia.

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    More about this item

    Keywords

    Diversification; Risk; Colombian Banking System.;
    All these keywords.

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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