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Universal Banking and the Pricing of Securities Risk: Historical Evidence from Germany

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  • Peter Bossaerts

    (California Institute of Technology)

  • Caroline Fohlin

    (California Institute of Technology)

Abstract

This paper investigates the importance of financial institutions, particularly universal banks, in the pricing of risk in securities markets. Recent research on modern economies, finds that three factors explain the cross-section of average stock returns: (i) a stock's sensitivity to market-wide price movements (``beta''), (ii) market capitalization, and (iii) book value of equity relative to its market price (the value effect). The German financial system of the pre-World War I period is a particularly informative case, since it enjoyed both a large and active stock market as well as powerful, relationship-oriented universal banks. In such a system, banks are often seen as particularly important for resolving information problems and may therefore improve risk sharing. If so, the three-factor model may fail to explain securities pricing. Banks (as opposed to finance companies and mutual funds) have diminished in importance in American corporate finance. One goal of this study, therefore, is to determine whether the decline of banks is irrelevant or is detrimental to social welfare. The future usefulness of banks hinges on their ability to contribute something that competitive markets cannot or do not. The theoretical literature offers conflicting hypotheses about this issue, making the question ultimately an empirical one. The study uses standard methodology in order to facilitate cross-reference to existing empirical literature. The methodology can be criticized on various asset-pricing theoretic grounds (most imortantly, it is not robust to deleting conditioning information). Nonetheless, such analyses have led to the discovery of several robust statistical regularities. While the approach clearly is not a formal test of a particular asset pricing model (the CAPM or APT), such models typically fail when confronted with the data. By using various sampling techniques, the analysis also estimates the importance of survivorship bias in the estimation of pricing models.

Suggested Citation

  • Peter Bossaerts & Caroline Fohlin, 2000. "Universal Banking and the Pricing of Securities Risk: Historical Evidence from Germany," Econometric Society World Congress 2000 Contributed Papers 1596, Econometric Society.
  • Handle: RePEc:ecm:wc2000:1596
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    References listed on IDEAS

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    1. Eugene F. Fama & Kenneth R. French, 1998. "Value versus Growth: The International Evidence," Journal of Finance, American Finance Association, vol. 53(6), pages 1975-1999, December.
    2. Michael Magill & Martine Quinzii, "undated". "Incentives And Risk Sharing In A Stock Market Equilibrium," Department of Economics 96-12, California Davis - Department of Economics.
    3. Ferson, Wayne E. & Sarkissian, Sergei & Simin, Timothy, 1999. "The alpha factor asset pricing model: A parable," Journal of Financial Markets, Elsevier, vol. 2(1), pages 49-68, February.
    4. Fohlin, Caroline M., 1999. "Company Law, Stock Market Regulation, and the Development of the German Financial System, 1880 - 1913," Working Papers 1065, California Institute of Technology, Division of the Humanities and Social Sciences.
    5. Jonathan B. Berk, 2000. "Sorting Out Sorts," Journal of Finance, American Finance Association, vol. 55(1), pages 407-427, February.
    6. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March.
    7. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    8. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, January.
    9. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    10. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    11. Michael Magill, 2000. "Equity, Options and Efficiency in the Presence of Moral Hazard," Econometric Society World Congress 2000 Contributed Papers 1845, Econometric Society.
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