Size Anomalies in U.S. Bank Stock Returns: A Fiscal Explanation

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.