Predictability in the cross-section of European bank stock returns

This paper investigates the impact of individual bank fundamental variables on NEWLINE stock market returns using data from a panel of 235 European banks from 1991 NEWLINE to 2005. The sample period marks a significant transition in the European banking NEWLINE sector, characterized by higher competition, lower profit margins in the traditional NEWLINE interest-related business and increasing non-interest income in terms of NEWLINE fees and commissions. In panel regressions, we relate bank stock returns to fundamental NEWLINE accounting information and use several corrections for the standard errors NEWLINE to control for heteroscedasticity, autocorrelation and spatial correlation. Our NEWLINE results indicate that several bank-specific variables exhibit a robust explanatory NEWLINE power across different model specifications. Most important, there is a positive NEWLINE impact of the ratio of loans to total assets, the ratio of non-interest income to total NEWLINE income, and the ratio of off-balance sheet items to total assets on subsequent NEWLINE bank stock returns. In contrast, the ratio of loan-loss-provisions to net interest NEWLINE revenue and the ratio of book value of equity to total assets load negatively on NEWLINE subsequent bank stock returns. Overall, the valuation of bank stocks incorporates NEWLINE both the traditional loan-related side of the banking business and the growing NEWLINE off-balance activities.