Linking and Weighting Efficiency Estimates with Stock Performance in Banking Firms

Belarmino Adenso-Díaz and Fernando Gascón

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: The purpose of this paper is to contribute further evidence on bank efficiency by defining alternative measures of costs when estimating efficiency and competitive viability by linking the results of efficiency estimates to market returns of financial institutions. Given a series of functions (production costs, opportunity costs of capital with systematic risk, opportunity cost of capital with specific risk, and branch network distribution), we estimate alternative partial measures of bank efficiency with DEA. Assuming that these functions are related to market returns on shares, an estimation of the relative importance of each of the functions is carried out, considering an additional initially unknown function which can be attributed to individual differences not accounted for in the previous four definitions. Due to the nature of the model, strong collinearity may be expected among efficiency measures. With the aid of a tabu search procedure, artificial instrumental variables are generated which avoid collinearity and permit the isolation of the underlying relationships. Results are applied to all Spanish banks quoting on the stock exchange.

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