The Determinants of Future Bank Stock Returns in Eight Asian Countries

Abstract

(ProQuest: ... denotes formulae omitted.)I. IntroductionCross-sectional asset pricing studies often treat financial institutions as outliers as they have higher leverage and are subject to a higher level of industry regulation than other sectors.1 Thus, information sources of the cross-sectional differences in future bank stock returns have not been explored much. For example, the popular three factor model by Fama and French (1992, 1993) demonstrates that the market risk, firm size, and book-to-market (BM) ratio explain the cross-sectional variation of stock returns. However, previous literature focusing on banking sector shows inconsistent results. Bessler et al. (2008) find that firm size and BM ratio are significant factors in future bank stock returns, while Cooper et al. (2003) show the opposite result.2 Moreover, when focusing on banking sector, exploring the link between bank-specific fundamental variables and the cross-section of expected bank stock returns was the main subject in the previous studies because bank-specific fundamental variables such as their ratios of net loans to total assets, equity to total assets, and non-performing loans to total assets show the bank capital and income structures. However, the previous studies reached no consensus on empirical methodology and results using these variables.3In particular, studies on emerging markets bank stock returns have been few. Most of the studies conducted before the 1990s focused on the relationship between debt crises and bank stock returns.4 In a more recent paper, Girard et al. (2010) analyze the impacts of both fundamental factors and country risk factors on bank stock returns in emerging markets. But they do not consider Asian banks' special characteristics and recent changes made around the Global Financial Crisis period. First, compared to advanced countries' banks, Asian banks have unique characteristics: they are highly dependent on domestic market; their major income source is interest income; and they are vulnerable to external shocks (Mohanty and Turner, 2010). Second, the Global Financial Crisis quickly spread to the world through increased interconnectedness in banking sector, especially, between European banks and the U.S. banks. Initially, the impacts of the negative shock from the crisis were relatively weak in Asian banks, which were not as integrated with the United States as European ones. However, as Rosengren (2012) pointed out in his speech, the correlation with the U.S. and European bank stock returns has increased overtime and Asian banks have certainly been impacted by the global slowdown since the crisis as Asian banks are in the transition to being integrated to the global financial markets. Their characteristics and increased correlation with the global market require that Asian banks be studied separately from banks in developed countries such as the United States and European countries.Asian banks also have another distinct characteristic compared to other emerging market banks. Mohanty and Turner (2010) evaluate that Asian banks not only have lower external exposures but also become better capitalized and more effective in managing their credit risks following the 1997 Asian currency crisis. With the help of favorable macroeconomic conditions, the structures of Asian banking assets and income statements have changed significantly over the past decade. The quality of assets held by banks has improved as the banks started to hold more cross-border claims, prompting their shares of liquid assets to grow rapidly. All these improvements in bank-specific fundamentals surely have impacts on the link with future bank stock returns.In this regard, this study examines the relationship between the cross-section of future bank stock returns and general asset pricing factors as well as bank-specific fundamental factors for a sample of eight Asian countries5 during the period from January 2000 to December 2010. …