Bank stocks, risk factors, and tail behavior

Abstract

We examine how the tail behavior of risk factors affects the tail behavior of individual bank stock returns in the United States. Using 26 common risk factors, we construct univariate and multivariate conditional exceedance measures. We find that returns on banking industry, security-trading industry, and broad market portfolios have the largest impact on the probability of observing high positive tail returns on bank stocks. A small-minus-big bank return factor, market volatility, and a profitability risk factor have the largest impacts on the probability of lower tail returns. Bank capital ratios and total allowances for loan losses are notably related to tail risk. • The tail risk of bank returns is highly sensitive to the tail risk of several underlying risk factors. • Tail risk can more than triple when key market risk factors exhibit extreme realizations. • Bank capital ratios and total allowances for loan losses are also notably related to tail risk.