Time-varying conditional beta, return spillovers, and dynamic bank diversification strategies

Abstract

This paper investigates how time-varying beta and return spillovers relate to bank diversification strategies conditional on market states, from a portfolio management approach. This paper explores the methods of estimating beta in a time-varying fashion for banking data. Further, it discovers the regime-switching relationship between bank betas and returns. Finally, this paper analyzes how the dynamic relationship between betas and returns implies to bank diversification strategies. The main findings are: 1) Bank betas are time-varying and the relationship between betas and returns in banking is regime-dependent; 2) banks use different diversification strategies in response to market movements conditional on market stability; 3) return spillovers among the banking industry affect bank returns through activity diversification.