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A Reconciliation of the Evidence about Bank Lending with Portfolio Theory

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  • Enzo Dia

    ()
    (University of Pavia and University of Strathclyde)

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Abstract

A Markowitz portfolio model is developed in this paper, in order to show how the optimal portfolio is changed if the bank forecasts a shock. It is shown that monetary and real shocks result in quite different patterns of reaction by the bank and these results do not depend on the existence of market power. The model allows to study the effect of different degrees of diversification of the portfolio and shows that the smoothing of shocks increases with the concentration of the portfolio. The shock determines a shift of the composition of the portfolio of assets: the bank increases the share of the less volatile assets that have a lower return as they charge a lower rate to the firm. This phenomenon emerges whenever a variation of the interest rates of any asset affects the cost or the volatility of the asset too, so that equiproportional variations of the rates affect net return and variance of different assets in a different way. The benefits of this kind of behaviour decline with the availability of a wider range of assets. These results are consistent with all the most recent empirical evidence.

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File URL: http://dipeco.economia.unimib.it/repec/pdf/mibwpaper56.pdf
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Bibliographic Info

Paper provided by University of Milano-Bicocca, Department of Economics in its series Working Papers with number 56.

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Length: 35 pages
Date of creation: Sep 2002
Date of revision: Sep 2002
Handle: RePEc:mib:wpaper:56

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  1. Mitchell Berlin & Loretta J. Mester, 1997. "On the profitability and cost of relationship lending," Working Papers 97-3, Federal Reserve Bank of Philadelphia.
  2. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon, 1996. "Safety in numbers? Geographic diversification and bank insolvency risk," Proceedings 504, Federal Reserve Bank of Chicago.
  3. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May.
  4. Berger, Allen N & Udell, Gregory F, 1992. "Some Evidence on the Empirical Significance of Credit Rationing," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 1047-77, October.
  5. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July.
  6. Sprenkle, Case M, 1969. "The Uselessness of Transactions Demand Models," Journal of Finance, American Finance Association, vol. 24(5), pages 835-47, December.
  7. Stiglitz, Joseph E & Weiss, Andrew, 1992. "Asymmetric Information in Credit Markets and Its Implications for Macro-economics," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 694-724, October.
  8. Fried, Joel & Howitt, Peter, 1980. "Credit Rationing and Implicit Contract Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 471-87, August.
  9. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon, 1996. "Safety in numbers? Geographic diversification and bank insolvency risk," Working Papers 96-14, Federal Reserve Bank of Philadelphia.
  10. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
  11. Hess, Alan C, 1995. "Portfolio Theory, Transaction Costs, and the Demand for Time Deposits," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1015-32, November.
  12. Anil Kashyap & Raghuram Rajan & Jeremy S. Stein, 1998. "Banks as liquidity providers: an explanation for the co-existence of lending and deposit-taking," Proceedings 582, Federal Reserve Bank of Chicago.
  13. Vale, Bent, 1993. " The Dual Role of Demand Deposits under Asymmetric Information," Scandinavian Journal of Economics, Wiley Blackwell, vol. 95(1), pages 77-95.
  14. Mitchell Berlin & Loretta J. Mester, 1997. "Deposits and relationship lending," Working Papers 96-18, Federal Reserve Bank of Philadelphia.
  15. Hess, Alan C, 1991. "The Effects of Transaction Costs on Households' Financial Asset Demands," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 383-409, August.
  16. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 651-66, November.
  17. D. J. Aigner & C. M. Sprenkle, 1968. "A Simple Model Of Information And Lending Behavior," Journal of Finance, American Finance Association, vol. 23(1), pages 151-166, 03.
  18. Cole, Rebel A., 1998. "The importance of relationships to the availability of credit," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 959-977, August.
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