Real Estate Market Risk in Bank Stock Returns: Evidence for the EU-15 Countries

Abstract

In countries with highly-developed financial systems bank portfolios have high exposure, directly or indirectly, to the real estate sector. Changes in the value of real estate can have a potentially significant impact on the default risk of banks and on their profitability as a result of this high exposure to the real estate sector. This scenario is especially critical during real estate crises, when bank losses tend to increase dramatically, placing the entire financial system at risk of collapse, as it was the case in the recent international subprime crisis. This article studies the sensitivity of bank stock returns to real estate returns. The results indicate that EU-15 bank stocks are sensitive to real estate returns; there is a positive relation between bank stock returns and real estate returns after controlling for general market conditions and interest rates. In particular, small banks with greater asset exposure to the real estate sector showed to be more sensitive to changes in the real estate returns.