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Risk overhang and loan portfolio decisions

  • Robert DeYoung
  • Anne Gron
  • Andrew Winton
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    Despite operating under substantial regulatory constraints, we find that commercial banks manage their investments largely consistent with the predictions of portfolio choice models with capital market imperfections. Based on 1990-2002 data for small (assets less than $1 billion) U.S. commercial banks, net new lending to the business, real estate, and consumer sectors increased with expected sector profitability, tended to decrease with the illiquidity of existing (overhanging) loan stocks, and was responsive to correlations in cross-sector returns. Small banks are most appropriate for this study, because they make illiquid loans and manage risk via on-balance sheet (non-hedged) diversification strategies.

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    File URL: http://www.chicagofed.org/digital_assets/publications/working_papers/2005/wp2005_04.pdf
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    Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-05-04.

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    Date of creation: 2005
    Date of revision:
    Handle: RePEc:fip:fedhwp:wp-05-04
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    8. DeYoung, Robert & Spong, Kenneth & Sullivan, Richard J., 2001. "Who's minding the store? Motivating and monitoring hired managers at small, closely held commercial banks," Journal of Banking & Finance, Elsevier, vol. 25(7), pages 1209-1243, July.
    9. Gron, Anne & Winton, Andrew, 2001. "Risk Overhang and Market Behavior," The Journal of Business, University of Chicago Press, vol. 74(4), pages 591-612, October.
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