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A Market-Based Risk Classification of Financial Institutions

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  • Alan C. Hess
  • Kirati Laisathit

Abstract

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. This paper was presented at the Financial Institutions Center's October 1996 conference on "

Suggested Citation

  • Alan C. Hess & Kirati Laisathit, 1996. "A Market-Based Risk Classification of Financial Institutions," Center for Financial Institutions Working Papers 96-37, Wharton School Center for Financial Institutions, University of Pennsylvania.
    • Handle: RePEc:wop:pennin:96-37
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    File URL: http://fic.wharton.upenn.edu/fic/papers/96/9637.pdf
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    References listed on IDEAS

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    1. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October.
    2. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    3. Edward J. Kane & Haluk Unal, 1988. "Change in Market Assessments of Deposit-Institution Riskiness," NBER Working Papers 2530, National Bureau of Economic Research, Inc.
    4. Benjamin M. Friedman & V. Vance Roley, 1985. "Aspects of Investor Behavior Under Risk," NBER Working Papers 1611, National Bureau of Economic Research, Inc.
    5. Jonathan A. Neuberger, 1991. "Risk and return in banking: evidence from bank stock returns," Economic Review, Federal Reserve Bank of San Francisco, issue Fall, pages 18-30.
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    Cited by:

    1. Beverly Hirtle, 1997. "Derivatives, Portfolio Composition, and Bank Holding Company Interest Rate Risk Exposure," Journal of Financial Services Research, Springer;Western Finance Association, vol. 12(2), pages 243-266, October.

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