Working Paper: NBER ID: w16553
Authors: Priyank Gandhi; Hanno Lustig
Abstract: The largest commercial bank stocks, ranked by total size of the balance sheet, have significantly lower risk-adjusted returns than small- and medium-sized bank stocks, even though large banks are significantly more levered. We uncover a size factor in the component of bank returns that is orthogonal to the standard risk factors, including small-minus-big, which has the right covariance with bank returns to explain the average risk-adjusted returns. This factor measures size-dependent exposure to bank-specific tail risk. These findings are consistent with government guarantees that protect shareholders of large banks, but not small banks, in disaster states.
Keywords: bank stock returns; size anomalies; government guarantees; risk-adjusted returns
JEL Codes: G01; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bank size (as measured by book value) (G21) | risk-adjusted returns (G12) |
| government guarantees (H81) | risk-adjusted returns (G12) |
| bank size (G21) | tail risk exposure (D81) |
| large banks (G21) | lower risk-adjusted returns (G11) |
| size-dependent exposure to bank-specific tail risk (F65) | risk-adjusted returns (G12) |
| regulatory environment (G38) | pricing of bank-specific tail risk (G19) |
| implicit guarantees (D83) | expected returns of large banks (G21) |
| loading on size factor (C39) | risk-adjusted returns of large banks (G21) |
| loading on size factor (C39) | risk-adjusted returns of small banks (G21) |
| size factor (P23) | risk-adjusted returns (G12) |