Economies of diversification in the banking industry: A frontier approach

Abstract

This paper defines a new measure, economies of diversification, to examine the cost effect of product line expansion. This measure is a special case of expansion path subadditivity and contains economies of scope as a special case. A nonparametric frontier technique which isolates the effects of inefficiency and scale is used to measure economies of diversification. Applied to a set of 468 U.S. depository institutions operating in 1984, we find slight diseconomies of diversification. Diseconomies of diversification and inefficiency due to the overutilization of resources are found to be more important determinants of bank costs than is the failure to operate at optimal scale.