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Bank diversification: laws and fallacies of large numbers

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  • Joseph G. Haubrich

Abstract

Conventional wisdom on bank diversification confuses risk with failure. This article clarifies the distinction and shows how increasing bank size may increase bank risk, even though it lessens the probability of failure and lowers the expected loss. The key result is an application of Samuelson's "fallacy of large numbers."

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File URL: http://www.clevelandfed.org/research/review/1998/98-q2-haubrich.pdf
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Bibliographic Info

Article provided by Federal Reserve Bank of Cleveland in its journal Economic Review.

Volume (Year): (1998)
Issue (Month): Q II ()
Pages: 2-9

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Handle: RePEc:fip:fedcer:y:1998:i:qii:p:2-9:n:v.34no.2

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Keywords: Bank size ; Bank failures ; Risk;

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References

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  1. Haubrich, Joseph G., 1990. "Nonmonetary effects of financial crises : Lessons from the great depression in Canada," Journal of Monetary Economics, Elsevier, Elsevier, vol. 25(2), pages 223-252, March.
  2. Thomson, James B, 1987. "The Use of Market Information in Pricing Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 19(4), pages 528-37, November.
  3. Boyd, John H. & Runkle, David E., 1993. "Size and performance of banking firms : Testing the predictions of theory," Journal of Monetary Economics, Elsevier, Elsevier, vol. 31(1), pages 47-67, February.
  4. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, Econometric Society, vol. 49(4), pages 911-20, June.
  5. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, Econometric Society, vol. 61(3), pages 589-611, May.
  6. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, Econometric Society, vol. 55(1), pages 143-54, January.
  7. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 19(3), pages 340-60, August.
  8. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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Cited by:
  1. Fields, L. Paige & Fraser, Donald R. & Kolari, James W., 2007. "Bidder returns in bancassurance mergers: Is there evidence of synergy?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 31(12), pages 3646-3662, December.
  2. James W. Kolari & Charles C. Ou & G. Hwan Shin, 2006. "Assessing the Profitability and Riskiness of Small Business Lenders in the Banking Industry," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, Pepperdine University, Graziadio School of Business and Management, vol. 11(2), pages 1-26, Summer.
  3. Gianni De Nicoló & M. G. Zephirin & Philip F. Bartholomew & Jahanara Zaman, 2003. "Bank Consolidation, Internationalization and Conglomeration," IMF Working Papers 03/158, International Monetary Fund.
  4. Sergio Sousa, 2010. "Small-scale changes in wealth and attitudes toward risk," Discussion Papers, The Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham 2010-11, The Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham.
  5. Rómulo Chumacero E. & Patricia S. Langoni, 2001. "Risk, Size and Concentration in the Chilean Banking System," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 4(1), pages 25-34, April.

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