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The Effects of Diversification on Banks´ Expected Returns

  • Dairo Estrada

    ()

  • Angela González Arbeláez

    ()

  • Javier Gutierréz Rueda

    ()

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.

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Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 004991.

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Length: 31
Date of creation: 14 Aug 2008
Date of revision:
Handle: RePEc:col:000094:004991
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  1. Dairo Estrada & Poldy Osorio, 2004. "Effects Of Financial Capital On Colombian Banking Efficiency," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
  2. Cerasi, Vittoria & Daltung, Sonja, 2004. "Multiple-bank lending: Diversification and free-riding in monitoring," CFS Working Paper Series 2004/18, Center for Financial Studies (CFS).
  3. Evelyn Hayden & Daniel Porath & Natalja Westernhagen, 2007. "Does Diversification Improve the Performance of German Banks? Evidence from Individual Bank Loan Portfolios," Journal of Financial Services Research, Springer, vol. 32(3), pages 123-140, December.
  4. repec:dgr:kubcen:200668 is not listed on IDEAS
  5. Ferrier, Gary D. & Lovell, C. A. Knox, 1990. "Measuring cost efficiency in banking : Econometric and linear programming evidence," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 229-245.
  6. Kevin Stiroh, 2004. "Do Community Banks Benefit from Diversification?," Journal of Financial Services Research, Springer, vol. 25(2), pages 135-160, April.
  7. V. Cerasi & S. Daltung, 1995. "The Optimal Size of a Bank: Costs and Benefits of Diversification," Departmental Working Papers 1995-05, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
  8. Allen N. Berger & Robert DeYoung, 2000. "The effects of geographic expansion on bank efficiency," Working Paper Series WP-00-14, Federal Reserve Bank of Chicago.
  9. Iftekhar Hasan & Anthony Saunders & Viral V. Acharya, 2002. "Should banks be diversified? Evidence from individual bank loan portfolios," BIS Working Papers 118, Bank for International Settlements.
  10. Clark, Jeffrey A, 1996. "Economic Cost, Scale Efficiency, and Competitive Viability in Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(3), pages 342-64, August.
  11. Berger, Allen N. & Hancock, Diana & Humphrey, David B., 1993. "Bank efficiency derived from the profit function," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 317-347, April.
  12. Denis, David J & Denis, Diane K & Sarin, Atulya, 1997. " Agency Problems, Equity Ownership, and Corporate Diversification," Journal of Finance, American Finance Association, vol. 52(1), pages 135-60, March.
  13. Hancock, Diana, 1986. "A model of the financial firm with imperfect asset and deposit elasticities," Journal of Banking & Finance, Elsevier, vol. 10(1), pages 37-54, March.
  14. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, 09.
  15. Winton, Andrew, 1997. "Competition among Financial Intermediaries When Diversification Matters," Journal of Financial Intermediation, Elsevier, vol. 6(4), pages 307-346, October.
  16. Dairo Estrada & Poldy Osorio, 2004. "Effects Of Financial Capital On Colombian Banking Efficiency," BORRADORES DE ECONOMIA 002432, BANCO DE LA REPÚBLICA.
  17. Dairo Estrada & Poldy Osorio, . "Effects of Financial Capital on Colombian Banking Efficiency," Borradores de Economia 291, Banco de la Republica de Colombia.
  18. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
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