The Cost of Capital of the Financial Sector

Abstract

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How Much of Bank Credit Risk Is Sovereign Risk? Evidence from Europe

“…We then turn to sorting the banks according to their indirect exposures. We find a strong positive and monotonic relationship between ROE and bank total sovereign exposures; this finding complements the evidence provided by Adrian, Friedman, and Muir () and on the importance of ROE in pricing bank equity funding costs. We also document a positive and monotonic relationship between bank size and bank–sovereign exposures, with banks in the High portfolio being four times bigger than those in the Low portfolio.…”

The Impact of CRD IV on Bank Lending

“…Since banks react to external shocks by adjusting their business models, the policy analysis should always focus on second-order (and potentially counterproductive) effects. While some evidence suggests that higher capital requirements reduce excessive risk-taking (Repullo, 2004) and that higher capital requirements correspond with a more resilient banking sector (Basten and Koch, 2015), the truly relevant question is whether regulation generates unintentional incentives to raise overall risk exposure (Adrian et al, 2015;Adrian and Shin, 2014;Blum, 1999), or incentives to shift towards shadow banking or off-balance sheet activities (Goodhart, 2008;Martin and Parigi, 2013;Plantin, 2015) or incentives to engage in regulatory arbitrage, that is, exporting the risk-taking to countries where regulation is less stringent (Ongena et al, 2013).…”

Estimating the Cost of Equity Capital for Insurance Firms With Multiperiod Asset Pricing Models

“…Fama–French five factors, the market return, and the risk‐free rate are from Ken French's data library . We calculate the financial industry factors according to Adrian, Friedman, and Muir (). All types of insurers are included and we further separate them into seven major subsectors .…”

“…The last two columns in Panel D of Table report the GRS test for the AFM model, which adds the spread between high and low ROE financial firms ( FROE ) and the return spread between financial and nonfinancial firms ( SPREAD ) to the old FF3 model, as well as the FF5 model augmented with the financial industry factors, namely, FROE and SPREAD (FF5 + AFM). Adrian, Friedman, and Muir () argue that the financial industry performance impacts the whole economy and thus can be a state variable. Panel D reveals that while the AFM and FF5 + AFM models outperform FF5, they still fall behind ICAPM and CCAPM (see Panel B).…”

“…In this study, we extend the insurance literature by examining two multi‐period models—the conditional CAPM (CCAPM) and the intertemporal CAPM (ICAPM). These two models are examined along with the single‐period models studied in the prior literature—the CAPM and FF3, as well as newer single‐period models like the Fama and French () five‐factor (FF5) model and the Adrian, Friedman, and Muir () (AFM) model with financial industry risk factors , . Our empirical analysis consists of three major parts.…”