Abstract
This paper assesses the impact of regulatory change on the risk and returns of the U.S. banking industry. The impact of five major regulatory changes on banking sector risk was assessed using daily data for eighteen major U.S. regional banks, money center banks and savings and loan type depository institutions. Risk in this case was proxied via the use of an M-GARCH model which generates time dependent conditional beta estimates. The evidence obtained suggests that the impact of deregulation and reregulation on banking sector risk is case specific. Further, the results obtained show that the market model incorporating dummy variables, which has proven so popular amongst existing studies, discards important information about the variability of beta which the time varying conditional betas capture.
Similar content being viewed by others
References
Aharony, J., A. Saunders, and I. Swary, “The Effects of DIDMCA on Bank Stockholders Return and Risk.” Journal of Banking and Finance 12, 317-31, (1988).
Alexander, G.J. and P.G. Benson, “More on Betas as a Random Coefficient.” Journal of Finance and Quantitative Analysis 17, 27-36, (1982).
Alexander, G.J., P.G. Benson, and C.E. Eger, “Timing Decisions and the Behavior of Mutual Fund Systematic Risk.” Journal of Finance and Quantitative Analysis 17, 579-602, (1982).
Alexander, J.C. and M.F. Spivey, “CEBA of 1987 and the Security Returns and Market Risk of Saving and loan Institutions: A Note.” Journal of Banking and Finance 18, 1205-1215, (1994).
Allen, P.R. and W.J. Wilhelm, “The Impact of the 1980 Depository Institutions Deregulation and Monetary Control Act on Market Value and Risk: Evidence from the Capital Markets.” Journal of Money, Credit and Banking 20, 364-380, (1988).
Baillie, R.T. and R.J. Myers, “Bivariate GARCH Estimation of the Optimal Commodity Futures Hedge.” Journal of Applied Econometrics 6, 109-124, (1991).
Barth, J.R., C. Pugh, and J.S. Jahera, “FIRREA and the Savings and Loan Industry: Was there a wealth effect?” Applied Financial Economics 31, 271-281, (1995).
Baumol, W.J., “Contestable Markets: An Uprising in the Theory of Industrial Structure.” American Economic Review 1-15, (1982).
Black and Moyer, The Structure of Bank Debt Contracts, Working paper, University of Wyoming, 1997.
Blume, M., “On the Assessment of Risk.” Journal of Finance 26, 1-10, (1971).
Blume, M., “Betas and the Regression Tendencies.” Journal of Finance 30, 785-795, (1975).
Bollerslev, T. “Modelling the Coherence in Short-Run Nominal Exchange Rates: A Multivariate Generalized ARCH model.” Review of Economics and Statistics 72, 498-505, (1990).
Bollerslev, T., R.Y. Chou, and K.F. Kroner, “ARCH Modeling in Finance.” Journal of Econometrics 52, 5-59, (1992).
Bos, T. and P. Newbold, “An Empirical Investigation of the Possibility of Stochastic Systematic Risk in the Market model.” Journal of Business 57, 35-41, (1984).
Brailsford, T.J. and T. Josev, “The Impact of the Return Interval on the Estimation of Systematic Risk.” Pacific Basin Finance Journal 5, 357-376, (1997).
Brooks, R., R. Faff, and Y.K. Ho, “A New Test of the Relationship Between Regulatory Change in Financial markets and the Stability of Beta Risk of Depository Institutions.” Journal of Banking and Finance 21, 197-219, (1997).
Bundt, T.P., T.F. Cosimano, and J.A. Halloran, “DIDMCA and Bank Market Risk: Theory and Evidence.” Journal of Banking and Finance 16, 1179-1193, (1992).
Caporale, T. and K. Doroodian, “Exchange Rate Variability and the Flow of International Trade.” Economics Letters 46, 49-54, (1988).
Cecchetti, S.G., R.E. Cumby, and S. Figlewski, “Estimation of the Optimal Futures Hedge.” The Review of Economics and Statistics 70, 623-630, (1988).
Cohen, K., G. Hawawini, S. Mayer, R. Schwartz, and D. Whitcomb, “Estimating and Adjusting for the Intervaling Effect Bias in Beta.” Management Science 29, 135-148, (1983a).
Cohen, K., G. Hawawini, S. Mayer, R. Schwartz, and D. Whitcomb, “Friction in the Trading Process and the Estimation of Systematic Risk.” Journal of Financial Economics 12, 263-278, (1983b).
Cohen, K., G. Hawawini, S. Mayer, R. Schwartz, and D. Whitcomb, The Microstructure of Security Markets, Prentice-Hall of Australia Ltd., Sydney, 1986.
Collins, D., J. Ledolter, and J. Rayburn, “Some Further Evidence on the Stochastic Properties of Systematic Risk.” Journal of Business 60, 425-448, (1987).
Dickens, R. and G. Philippatos, “The Impact of Market Contestability on the Systematic Risk of U.S. Bank Stocks.” Applied Financial Economics 4, 315-322, (1994).
Engle, R.F., “Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation.” Econometrica 50(4), 987-1007, (1982).
Engle, R. and K. Kroner, “Multivariate Simultaneous Generalized ARCH.” Econometric Theory 11, 122-150, (1995).
Fabozzi, F.J. and J.C. Francis, “Beta as a Random Coefficient.” Journal of Financial and Quantitative Analysis 13, 101-115, (1978).
Fabozzi, F.J., J.C. Francis, and C.F. Lee, “Specification Error, Random Coefficient and the Risk-Return Relationship.” Quarterly Review of Business and Economics 2, 23-30, (1982).
Francis, J.C. and F.J. Fabozzi, “Stability of Mutual Fund Systematic Risk Statistics.” Journal of Business Research, 8, 263-275, (1980).
Frankfurter, G., W. Leung, and P. Brockman, “Compounding Period Length and the Market Model.” Journal of Economics and Business 46, 179-193, (1994).
Fraser, D.R. and J.W. Kolari, “The 1982 Depository Institutions Act and Security Returns in the Savings and Loan Industry.” The Journal of Financial Research 13, 339-347, (1990).
Gonzales-Rivera, G., “Time-Varying Risk The Case of the American Computer Industry.” Journal of Empirical Finance 2, 333-342, (1996).
Graddy, D.B., R. Kyle, and T.H. Strickland, “The Differential Effects of Deregulation on Savings and Loan Associations and Banks.” The Journal of Financial Research 17, 289-300, (1994).
Hall, S.G., “An application of the Stochastic GARCH-in-Mean Model to Risk Premia in the London Metal Exchange.” The Manchester School 59, 57-71, (1991).
Handa, P., S.P. Kothari, and C. Wasley, “The Relation Between the Return Interval and Betas: Implications for the size effect.” Journal of Financial Economics 23, 79-100, (1989).
Hawawini, G., “Why Beta Shifts as the Return Interval Changes.” Financial Analysts Journal 39, 73-77, (1983).
Hentschel, L., “All in the family: Nesting symmetric and asymmetric GARCH models.” Journal of Financial Economics 39, 71-104, (1995).
Hogan, W. and I. Sharpe, “Regulation Risk and the Pricing of Australian Bank Shares 1957-1976.” The Economic Record 60, 34-44, (1984).
Koutmos, G., U. Lee, and P. Theodossiou, “Time-Varying Betas and Volatility Persistence in International Stock Markets.” Journal of Economics and Business 46, 101-112, (1994).
Kroner, K.F. andW.D. Lastrapes, “The Impact of Exchange Rate Volatility on International Trade: Reduced form estimates using the GARCH-in-mean model.” Journal of International Money and Finance 12, 298-318, (1993).
Liang, Y., S. Mohanty, and F. Song, “The Effect of the Federal Deposit Insurance Corporation Improvement Act of 1991 on Bank Stocks.” Journal of Financial Research 19, 229-242, (1996).
Madura, J., A.L. Tucker, and E.R. Zarruk, “Market Reaction to the Thrift Bailout.” Journal of Banking and Finance 17, 591-608, (1993).
Madura, J. and K. Bartunek, “Valuation Effects of the FDIC Improvement Act.” Applied Financial Economics 5, 191-198, (1995).
Mansur, I. and E. Elyasiani, “An Examination of the Impact of the 1989 FIRREA on the Market Value of Commercial Banks and Savings and Loans.” Applied Financial Economics 4, 11-22, (1994).
Millon-Cornett, M.H. and H. Tehranian, “Stock Market Reactions to the Depository Institutions Deregulation and Monetary Control Act of 1980.” Journal of Banking and Finance 13, 81-100, (1989).
Millon-Cornett, M.H. and H. Tehranian, “An Examination of the Impact of the Garn-St. Germain Depository Institutions Act of 1982 on Commercial Banks and Savings and Loans.” Journal of Finance 45, 95-111, (1990).
Ohlson, J. and B. Rosenberg, “Systematic Risk of the CRSP Equal-Weighted Common Stock Index: A history estimated by stochastic parameter regression.” Journal of Business 55, 121-145, (1982).
Pagan, A., “The Econometrics of Financial Markets.” Journal of Empirical Finance 3, 15-102, (1996).
Peltzman, S., “Toward a More General Theory of Regulation.” The Journal of Law and Economics 211-240, (1976).
Sephton, P.S., “Optimal Hedge Ratios at theWinnipeg Commodity Exchange.” Canadian Journal of Economics 26, 175-193, (1993).
Shiers, A.F., “Deposit Insurance and Banking System Risk: Some Empirical Evidence.” The Quarterly Review of Economics and Finance 34, 347-361, (1994).
Simmonds, R., L. La Motte, and A. McWhorter, “Testing for Nonstationarity of Market Risk: An exact test and power considerations.” Journal of Finance and Quantitative Analysis 21, 209-220, (1986).
Song, F.M., “ATwo-Factor ARCH Model for Deposit-Institution Stock Returns.” Journal of Money, Credit and Banking 26, 323-340, (1994).
Stigler, G., “The Theory of Economic Regulation.” Bell Journal of Economic and Management Science 2, 3-21, (1971).
Sundaram, S., N. Rangan, and W.N. Davidson, “The Market Valuation Effects.” Journal of Banking and Finance 16, 1097-1122, (1992).
Sunder, S., “Stationarity of Market Risk: Random coefficient tests for individual stocks.” Journal of Finance 35, 883-896, (1980).
Author information
Authors and Affiliations
Rights and permissions
About this article
Cite this article
Brooks, R.D., Faff, R.W., McKenzie, M.D. et al. U.S. Banking Sector Risk in an Era of Regulatory Change: A Bivariate GARCH Approach. Review of Quantitative Finance and Accounting 14, 17–43 (2000). https://doi.org/10.1023/A:1008324023419
Issue Date:
DOI: https://doi.org/10.1023/A:1008324023419