The Cross Section of Bank Value

Mark  Egan; Stefan  Lewellen; Adi   Sunderam

Working Paper | 2017

The Cross Section of Bank Value

by Mark Egan, Stefan Lewellen and Adi Sunderam

Abstract

We study the determinants of value creation within U.S. commercial banks. We begin by constructing two new measures of bank productivity: one focused on deposit-taking productivity and one focused on asset productivity. We then use these measures to evaluate the cross-section of bank value. Both productivity measures are strongly value relevant, with variation in banks' deposit productivity responsible for the majority of variation in bank value. We also find evidence consistent with synergies between deposit-taking and lending activities: banks with high deposit productivity have high asset productivity, a relationship driven by the tendency of deposit-productive banks to hold illiquid loans. Our results suggest that both sides of the balance sheet contribute meaningfully to bank value creation, with the liability side playing a primary role.

Keywords: banks and banking; productivity; Banks and Banking; Valuation; Performance Productivity; Value Creation;

Language: English

Format: Print

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Citation:

Egan, Mark, Stefan Lewellen, and Adi Sunderam. "The Cross Section of Bank Value." NBER Working Paper Series, No. 23291, March 2017. (Revise and Resubmit at the Review of Financial Studies.)

We develop a model in which risk-averse, specialized bond investors must be paid to absorb shocks to the supply and demand for long-term bonds in two currencies. Since long-term bonds and foreign exchange are both exposed to unexpected movements in short-term interest rates, our model naturally links the predictability of long-term bond returns to the predictability of foreign exchange returns. Specifically, a shift in the net supply of long-term bonds in one currency influences bond term premiums in both currencies as well as the foreign exchange rate between the two currencies. Our model matches several important empirical patterns, including the co-movement between exchange rates and bond term premiums as well as the finding that central banks' quantitative easing policies impact not only local-currency long-term yields, but also foreign exchange rates. We also show that this quantity-driven approach provides a unified account explaining both why foreign exchange tends to outperform when the foreign interest rates exceed domestic rates and why long-term bonds tend to outperform when the yield curve is steep.

Working Paper | HBS Working Paper Series | 2019

The Value of Intermediation in the Stock Market

Marco Di Maggio, Mark Egan and Francesco Franzoni

Brokers continue to play a critical role in intermediating institutional stock market transactions. More than half of all institutional investor order flow is still executed by high-touch (non-electronic) brokers. Despite the continued importance of brokers, we have limited information on what drives investors' choices among them. We develop and estimate an empirical model of broker choice that allows us to quantitatively examine each investors' responsiveness to execution costs and access to research and order flow information. Studying over 300 million institutional trades, we find that investor demand is relatively inelastic with respect to commissions and that investors are willing to pay a premium for access to top research analysts and order-flow information. There is substantial heterogeneity across investors. Relative to other investors, hedge funds tend to be more price insensitive, place less value on sell-side research, and place more value on order-flow information. Furthermore, using trader-level data, we find that investors are more likely to trade with traders who are located physically closer and are less likely to trade with traders that have misbehaved in the past. Lastly, we use our empirical model to investigate the unbundling of equity research and execution services related to the MiFID II regulations. While under-reporting for the average firm is relatively small (4%), we find that the bundling of execution and research allows some institutional investors to under-report management fees by up to 15%.

Keywords: financial intermediation; Institutional investors; research analysts; Financial Institutions; Investment; Financial Services Industry;

Citation:

Di Maggio, Marco, Mark Egan, and Francesco Franzoni. "The Value of Intermediation in the Stock Market." Harvard Business School Working Paper, No. 20-016, August 2019. View Details

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We present a framework for analyzing “model persuasion,” where persuaders influence people’s beliefs by proposing models (likelihood functions) that suggest how to organize past data (e.g., on investment performance) to make predictions (e.g., about future returns). Receivers are assumed to find models more compelling when they better explain the past. A key tradeoff persuaders face is that models that better fit the data induce less movement in receivers’ beliefs. Model persuasion sometimes makes the receiver worse off than if he interprets data through the lens of a default model. The receiver is most misled by persuasion when there is a lot of publicly available data that is open to interpretation and exhibits randomness, as this gives the persuader “wiggle room” to highlight false patterns. Even when the receiver is exposed to the true model, the wrong model often wins because it better fits the past. Competition more broadly pushes persuaders towards overfitting available data and as a result tends to neutralize the data by leading receivers to view it as unsurprising. With multiple receivers, a persuader is more effective when receivers share similar priors and default interpretations. We illustrate with examples from finance, politics, and law.

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The Cross Section of Bank Value

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