The Effects of Diversification on Banks´ Expected Returns

Dairo Estrada (), Angela Gonzalez and Javier Gutiérrez Rueda

No 4991, Borradores de Economia from Banco de la Republica

Abstract: In financial theory, the optimal allocation of assets and its relationship withprofitability has been one of the main concerns; the question has always been ifbanks should focus or diversify their assets. In our case, we would like to answerthis question focusing in diversification of the loan portfolio, presenting a theoreticalmodel that considers the possible gains from diversification, while taking intoaccount the effects of monitoring. Additionally, we present empirical evidence onthis matter for the Colombian banking system. According to the model, we findthat once the banks have chosen its optimal level of monitoring, expected return isalways higher when the bank decides to focus. Additionally, the empirical resultssuggest that there are no possible gains form diversification in bank´s cost and that,on average, the effects of focusing the loan portfolio reduces bank´s return whileshowing positive effects of focusing on an specific sector.

Keywords: Diversification; Risk; Colombian Banking System. (search for similar items in EconPapers)
JEL-codes: G00 G21 G30 (search for similar items in EconPapers)
Pages: 31
Date: 2008-08-14
New Economics Papers: this item is included in nep-ban
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: The Effects of Diversification on Banks’ Expected Returns (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:col:000094:004991

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