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Credit Quality and Stock Returns of Commercial Banks

Nawazish Mirza (), Amir Hasnaoui () and Birjees Rahat ()
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Amir Hasnaoui: La Rochelle Business School - Excelia Group
Birjees Rahat: La Rochelle Business School - Excelia Group

Economics Bulletin, 2020, vol. 40, issue 1, 1-17

Abstract: Commercial banks exhibit distinctive dynamics that are priced in their stock returns. This paper evaluates conventional asset pricing models using an exchange rate adjusted portfolio of banking firms from fourteen European countries and proposes a banking specific risk factor. Our findings suggest that credit quality premium (proportion of non-performing loans to total loans and measured as BdMGd - bad minus good) is systematic in nature. Hence, investors demand incremental risk premium for investing in banking stocks with lower credit quality. We also note that the credit quality premium is more significant for banks that are smaller in size. We conclude that the variation in stock returns for banking firms is better explained by an asset pricing framework augmented for credit quality as compared to conventional pricing propositions. These findings have considerable implications for portfolio management and pricing of banking equities, notably in an international context.

Keywords: Banking Stocks; Credit Quality; International Portfolios (search for similar items in EconPapers)
JEL-codes: G1 (search for similar items in EconPapers)
Date: 2020-01-01
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