Bank Risk and Real Estate: An Asset Pricing...

Journal of Real Estate Finance and Economics, 10: 199-224 (1995)0 1995 Kluwer Academic Publishers

Bank Risk and Real Estate: An Asset Pricing Perspective

JIANPING ME1 AND ANTHONY SAUNDERSLeonard N. Stern School of Business, New York University, 900 Tisch Hall, New York, NY 10003

Abstract

While a number of papers have investigated the time-series behavior of expost bank stock returns and real estatereturns, no study has comprehensively studied the relationship between ex ante risk premiums on both assetsand the time-varying nature of such premiums in relationship to economic and real estate market conditions.In this study, we investigate how the changing nature of bank risk taking, especially in the real estate market,has affected the ex anre pricing of risk in the market for bank stocks. We tind that the time variation in bankrisk premiums are partly determined by interest rate and real estate market conditions. We also discover thatthe real estate factor has been important for banks in the 1980s.

Key Words: real estate factors, money center banks

The 1980s have posed many loan management problems for large U.S. banks. In the early1980s these banks faced growing problems in both their LDC and oil and gas loan port-folios. In the mid-1980s farming and agricultural loans were added to this list, and morerecently, especially since 1987, commercial real estate has become a new problem loanarea. By contrast, the 1970s are often viewed as a period of relative growth and prosperityfor U.S. banking.

This unfolding of asset-exposure problems for major U.S. banks raises an important em-pirical question: To what extent do investors price such risks in the market? Previous studiesof bank stock returns, such as Aharony, Saunders, and Swary (1986), Flannery (1983),Flannery and James (1984)) and James (1989) have concentrated on explaining the ex postbehavior of bank stock returns, usually in an augmented two-factor return-generating modelwith a market and interest rate risk factor. However, no study has formally sought to iden-tify whether such factors are prices ex ante, in the sense of the APT, or whether the influ-ence of such factors changes over time as banks alter the nature of their loan exposures.Perhaps the paper closest to ours is by Sweeny and Warga (1986) who investigated theex ante premiums in the pricing of public utility stocks in the presence of a market andinterest rate risk factors. However, their methodology was too constraining in that theirpremiums were fixed (constant) through time.

In this paper we use data for 1970-1989 on large bank stock returns to investigate thetime-varying nature of three sources of ex ante risk: (i) the market factor, (ii) an interestrate factor, and (iii) a real estate factor. In light of the problems of many large banks inthe real estate market, where at the end of 1990 ten major banks had commercial real estateloan portfolios exceeding $3.5 billion each, and their problem commercial real estate loan-net worth ratios exceeded 30%) considerable attention is given to the exposure to and the

200 JIANPING ME1 AND ANTHONY SAUNDERS

pricing of real estate risk in bank stock returns. Moreover, since banking is a regulatedindustry, we try to identify regulatory induced impacts on these risk premiums. In particu-lar, we seek to identify whether changes in the Federal Reserve’s monetary policy regime(e.g., October 1979 to October 1982) affected the relative pricing of risk.

It is important for banks to understand the determinants of equity risk premium, sincethis premium not only affects their investment decision but also their financing decision.As is well known, the weighted average cost of capital (WACC) is a weighted average ofthe costs of debt and equity. The higher the equity risk premium, the higher the requiredrate of return on equity, and thus, the higher the WACC. The variation of risk premiumis also of interest to regulators because it contains information about market perceptionof bank risk. Thus, if banks have increased their exposures to certain risks, regulators shouldconsider actions, such as additional loss provisioning, additional capital infusion, as wellas revising the required deposit insurance premium paid.

In Section 1 we outline the methodology of our study. In particular we employ a multi-factor latent-variable model on the lines of Campbell (1987), Campbell and Hamao (199 l),and Ferson (1989) to derive time-varying ex ante (or expected) risk premiums. In Section 2the estimation procedure is described. This is followed by a description of data in Section3. Section 4 presents the empirical results and Section 5 is a summary and conclusion,in which we discuss our major findings: the time variation in bank risk premiums are pre-dictably affected by a real estate market condition variable, and the real estate factor hasbeen important in the 1980s for banks.

1. The Asset Pricing Framework

Following, Campbell and Hamao (199 1)) Ferson ( 1989)) and Liu and Mei ( 1993), we assumethat asset returns are generated by the following K-factor model:

;i,t+l = Et[ri,t+ll +k PikC,t+l + ti,t+l (1)k=I

where ri,r+i is the return on asset i, held from time t to time t + 1, in excess of the risk-free (treasury bill) rate. Er [ ?,r+i] is the expected excess return on asset i, conditional oninformation known to investors at time t. The unexpected return on asset i equals the sumof K factor realizations f;c,$+t times their betas or factor loadings Pik, plus an idiosyncraticerror term ti,i+i. We assume also that E,[f&+i] = 0, E,[E?,,r+,] = 0, and E[

AN ASSET PRICING PERSPECTIVE 201

where Xkt is the “market price of risk” for the kth factor at time t. Equation 2 states thatthe conditional expected excess return, or ex ante risk premium on a stock should be aweighted average of factor risk premiums, with the weights equal to the betas of the stock.Now suppose that the information set at time t consists of a vector of L (L > K) economicor forecasting variables Xpt, p = 1 . . L, and that conditional expectations are linear inthose variables! Then we can write Xkt as

Xkt =k ekpXpt,p=l

and substituting, we have

Et[~i,t+,l =2 bik 2 OkpXpt =i aylpxpt.k=l p=l p=l

(3)

Equation 4 suggests that expected excess returns are time-varying and can be predictedby the economic variables, X,,, in the information set. It is easy to see from equation 4that the model puts some restrictions on the coefficients of equation 4. These are

where fiik and 8kj are free parameters.The main differences between this model and the model employed by Sweeny and Warga

(1986) are that we allow for time-varying factor premiums as a result of a changing eco-nomic environment, and we do not assume that the factors in the model can be observeda priori. Instead, we let the data tell us whether certain factors, such as the market risk,interest rate risk, and real estate market risk are systematic factors that affect bank stockreturns. This added flexibility allows us to use equation 4 to examine the degree to whicheconomic (or “forecasting”) variables, X,, explain the ex ante time-variation in expectedexcess returns on bank stocks. We can also use the model to examine the extent to whichvarious economic risks drive the expost movements in bank stock returns. As noted above,previous studies have concentrated on the ex post pricing of risk in bank stock returns,as opposed to the ex ante pricing of risk.

It is worth noting that part of equation 4 can be derived directly from linear projectionswithout using the asset pricing framework of equations l-3. In other words, given that con-ditional expectations are linear in the forecasting variables, we will have

Eitii,i+iI =$ oipXptp=l

(4’)


This is an important observation, since it implies that the unconstrained conditional riskpremium estimated using equation 4 ‘, does not depend on the assumption that beta coeffi-cients are constant through time, or the other restrictions imposed by the asset pricing model.Thus, the sensitivities of bank stocks toward economic changes can vary over time, as longas the product of beta and factor premiums are linear in these economic variables.

2. The Estimation Procedure

A generalized method of moments (GMM) approach, similar to Campbell (1987)) Camp-bell and Hamao (1991), and Ferson (1989) is employed to estimate equation 4 ’ and to testthe asset pricing restriction of (5). Equation 5 is a cross-equation restriction with unknownparameters; thus equation 4 must be estimated simultaneously across a number of assetsto appropriately test the restriction. To ensure that the linear pricing condition holds fora wide range of assets, we use returns of five asset portfolios: the value-weighted indexof NYSE and AMEX stocks, a long-term U.S. government bond portfolio, an equally-weighted index of real estate investment trust (REITs), a portfolio of money center banks,and a portfolio of nonmoney center banks. In other words, a wide range of asset portfoliosare needed to test the asset pricing model restriction and study the risk premiums on stocksof money center banks and nonmoney center banks.

The forecasting variables chosen reflect those widely used in previous stock return studies(see Campbell, 1987; Fama and French, 1989; Keim and Stambaugh, 1986; Ferson andHarvey, 1989; Liu and Mei, 1991, among others), and which can be expected to act asimportant variables in our study. These variables are a January dummy, the dividend yieldon an equally weighted market portfolio, the level of interest rates, the spread betweenthe yields on long-term AAA corporate bonds and the one-month treasury bill rate, anda proxy for the earnings-price ratio on a large well-diversified portfolio of real estate assets(the capitalization rate)? Although all these variables have been found to be useful in ex-plaining the time-variation in expected returns on regular stocks, the last three variablesmay have particular relevance to the expected return on bank stocks.

The treasury bill rate proxies for the level of interest rates. Changes in the level of inter-est rates will affect banks according to whether they mismatch the duration of their assetand liability portfolios and the direction of any such mismatch. Most studies of bank port-folios have concluded that on average banks have longer-term asset durations than liabilitydurations (see Bernanke, 1990, for example)? As a result, given any positive duration gap,an expected rise in the level of rates, increases bank exposure to interest-rate risk. Thusin periods when interest rates are higher (or lower) than normal we might expect a changein the interest-rate risk premium to be impounded in bank stock returns. In particular, wewill expect a negative relationship when rates are high if the market expects interest ratesto revert to some normal level!

The spread between the yield on long-term AAA bonds and the treasury bill rate proxiesfor the default risk exposure of banks. A widening of the corporate bond-bill rate spreadreflects investors’ expectations of increased default risk in the corporate sector (see Friedmanand Kuttner, 1991, for example) and thus may be interpreted as reflecting increased defaultrisk exposure on bank loans.


The capitalization rate (cap-rate) on real estate assets seeks to capture changing expecta-tions regarding future expected returns in the residential and commercial real-estate markets?The capitalization rate is equal to the earnings-price ratio on direct real estate investments.An increase in the risk of real estate investment, such as a glut of new commercial proper-ties, will increase the required rate of return on real estate and thus lower the market valueof real estate assets. This will result in an increase in the cap-rate. The cap-rate is con-structed as the ratio of net stabilized earnings to the market-value (market price) of a welldiversified property portfolio. The stabilized earnings factor adjusts actual earnings so thateach holding in the property portfolio reflects a vacancy rate no higher than that exists forother buildings in the same (local) market (see Liu and Mei, 1992). These real estate dataare reported by the American Council of Life Insurance (ACLI) publications (various issues).

3. Data

The forecasting (economic) variables, discussed above were derived from a number ofsources. Real-estate capitalization rates were taken from the ACLI quarterly publicationInvestment Bulletin (various issues). Yields on one-month bills and data for the AAA corpo-rate bond-treasury bill spread were derived from the Federal Reserve Bulletin and Ibbotsonand Associates (1989). The dividend yield variable, defined as the dividend paid duringthe last twelve months divided by current market price, was derived by using divided andprice information on the CRSP file.

3.1. Bank Stock Returns

We used Compustat to identify the appropriate banks and bank-holding companies in oursample for the 1971:2-1989:4 period. The bank group was divided into a money centerbank (MCBs) group and a nonmoney center bank (NMCBs) group. This was done to exam-ine whether there was any differential sensitivity to real estate (and other factors) betweenthe largest banks and the more regionally specialized large nonmoney center banks. Themoney center bank group contained a total of eleven banks6 while the nonmoney centergroup contained a total of 180 banks. We used all banking firms listed on Compustat overthe period, not just those with a continuous trading history, so as to avoid a selection bias.As a result approximately 90 banks are contained in the nonmoney center bank sampleat any given time.

Based on the money center and nonmoney center classifications, two montly return serieson equally-weighted bank stock portfolios are derived from the CRSP (daily) tapes.

3.2. Other Portfolio Returns

The market portfolio returns and the returns on long-term U.S. bonds were also derivedfrom the CRSP tapes. The government bond return series was employed below to reflectthe degree to which bank stock returns (which are claims on underlying portfolios of fixed


and variable rate, riskless, and risky bonds) mimicked the return behavior of bond assetsrather than stocks. The government bond portfolio was formed from a portfolio of non-callable twenty-year Treasury bonds. The (stock) market portfolio comprised of the value-weighted index of NYSE and AMEX stocks.

In addition to a money center, a nonmoney center, a stock return portfolio, and a bondreturn portfolio, we also analyze the comparative predictability of returns on a REIT port-folio. We construct an equally-weighted equity REIT return series using all equity REITson the CRSP from January 1971 to December 1989. All equity REITs are included, notjust those having a continuous price history over the period in question to avoid the prob-lem of survivorship bias. The REIT portfolio consists of 50 equity REITs on average. AREIT is deemed to be an equity REIT if it is listed as such on at least two of the followingthree sources: (1) REZT Sourcebook published by the National Association of Real EstateInvestment Trusts, Inc., (2) 7Fze Realty Stock Review published by Audit Investments, or(3) Moody’s Bank and Finance Manual, Volume 2.

4. Empirical Results

Table 1 provides summary statistics for the variables used in this study. Panel A providesdata on the monthly means, standard deviations (SDS) and first-order autocorrelations onfive portfolios: (i) the market portfolio, (ii) the government bond portfolio, (iii) the REITportfolio, (iv) the nonmoney-center bank (NMCB) portfolio, and (v) the money-center bank(MCB) portfolio.

As can be seen, both MCBs and NMCBs had higher excess returns on their portfoliosthan both the market and the bond portfolio. However, their excess returns were lower thanthose for the portfolio of REITs. Interestingly, the excess mean return on the MCBs port-folio (0.381%) was lower than that for the NMCBs portfolio (0.401%) even though MCBbanks had a higher standard deviation of returns (6.415% vs. 4.783%). Bank stock returnsin general also appeared to exhibit a higher degree of first-order autocorrelation than thenonbank portfolios (assets).

In Table 1, panel B, the sample is divided into three subsamples approximating the threemonetary policy regimes that existed over this period. Specifically the mid subsample(1979: 10-1982: 10) is viewed as a period of relatively high interest rate volatility comparedto the other two subsample periods. As can be seen, while the mean excess returns forNMCBs increase over three subperiods, those for MCBs were actually highest in 1979: lo-1982: 10 even though the underlying volatility of returns was highest in 1982: 1 l-1989:3.Thus the subperiod results suggest that MCB and NMCB stocks have diverged in theirreturn performance during the 1980s with the MCB stocks generating lower mean excessreturns than NMCB stocks despite increasing relative return risk. Such evidence is consis-tent with the existence of implicit deposit insurance and safety-net guarantees for large moneycenter bank investors in the 1980s which divorced the required returns on bank stocksfrom the underlying riskiness of bank portfolios (see O’Hara and Shaw, 1990).

In Table 1, panel D, the correlation among excess returns of the market, bond, REIT,NMCBs, and MCBs portfolio are shown for the whole period. As can be seen both NMCBsand MCBs are more highly correlated with the REIT portfolio than with the bond portfolio.

AN ASSET PRICING PERSPECTIVE

Table 1. A. Summary statistics for 1971:2-1989:4

205

Mean (%) S.D. (%) PI

Dependent Variables:Excess return on the market portfolioExcess return on government bond portfolioExcess return on RElTs portfolioExcess return on NMCBs portfolioExcess return on MCBs portfolio

0.282 4.822 0.0550.038 3.287 0.0500.679 4.887 0.1150.401 4.783 0.2300.381 6.415 0.151

B. Summary statistics for subperiods

Mean (%) SD. (%) Mean (%) S.D. (%) Mean (%) S.D. (%)

Subperiods 1971:2-1979:9 1979:10-1982:10Market 0.018 4.627 0.043 5.373Bonds -0.088 1.953 -0.344 5.440REITs 0.573 5.889 0.863 5.276NMCBs -0.052 4.616 0.469 5.137MCBs 0.058 6.090 0.834 6.475

C. Correlations among excess returns of different assets

1982:l l-1989:30.748 4.8310.382 3.3820.732 2.8600.974 4.8270.598 6.856

Market Bonds REITs NMCBs MCBs

Market 1 .ooo 0.317 0.639 0.818 0.670Bonds 1.000 0.186 0.345 0.355REITs 1.000 0.734 0.606NMCBs 1.000 0.845MCBs 1.000

Notes: MCBs stands for money center banks, and NMCBs represents nonmoney center banks, The sample periodfor this table is 1971:2-1989:4, with 219 observations. Units on excess returns are percentage points per month.Units on one-month T-bill rate, term spread, dividend yield, and cap rate are percentage per annum. p, is thefirst-order autocorrelation coefficient of the series,

This suggests that bank exposure to real-estate risk may be as important if not more impor-tant than their exposure to interest rate risk (as reflected in bond returns)!

The relationship between the excess returns on MCB stocks and REITs is also shownin Figure 1. While MCB stock returns appear to be less volatile than REITs in the 1970sthey become more volatile in the 1980s. This is consistent with real estate factors havinga relatively greater influence on bank stocks in the most recent decade as large banks ex-panded their loan portfolios in the real estate area.

Table 2 examines the extent to which the forecasting variables (the January dummy, thedividend yield, the treasury bill yield, the corporate-treasury bill spread, and the cap-rateon real estate assets) explain the time-variation in ex ante excess returns on our five assetportfolios-and in particular, the ex ante excess returns on MCB and NMCB stocks. Thet-statistic has been adjusted for heteroskedasticity and serial correlation in the regressionusing the GMM approach.

The most interesting finding here is the significant contribution (at 5 % level) to the pre-dictability of NMCB returns by the real estate variable (the cap rate). As we can see from


-

I 7 2 71. 7 6 7 8 8 0 8 2 84 t36 8 8 9 0Time Period: 1 9 7 1 .2- 1 9 8 9 . 4

Figure 1. Excess returns on REITs and MCBs

the regression, the market will demand a high risk premium (expected excess returns) whenthe real estate market cap rate is high, and a lower risk premium will suffice if the caprate is low. Since the cap rate is an indicator of real estate market condition, we can con-clude that the risk premium on large nonmoney center banks is highly influenced by realestate market conditions. The interest rate variable also affects NMCB premiums in theexpected direction.

To make sure that our results on NMCB are not driven by the small firm effect or theJanuary effect, we here also provide the regression result for a small firm portfolio! Althoughall coefficients are of same signs, it is worth noting that the January effect is much smallerfor NMCB stocks while the same effect is much stronger in REIT. We can also see thatshort-term interest rates (T-bill) have a smaller effect on NMCB stocks comparing to thaton REIT and small stocks. The term spread has a positive (insignificant) effect on the twobank portfolios but a negative effect on REIT and small stocks.

Nevertheless, while interest rate and real estate variables have the expected signs they arenot statistically significant in the MCB regression. Overall, approximately 8.2% of thevariation in monthly excess returns on NMCBs (compared to 3 % on MCBs) is accountedfor by our five forecasting variables after adjusting for degrees of freedom. Thus, the sim-ple unconstrained version of the latent variable model implies greater interest rate and realestate exposure for large nonmoney center banks relative to money center banks!


Table 2. Difference between MCB and NMCB in unrestricted conditional risk premiums.

rl.t+l = Cons. + p, Jandum + &T-Bill, + &Spread, + flqDivYld, + &CapRate, + i,

Asset Class Constant Jandum T-bill Spread DivYld CapR ti2 DW

Market -7.408** 1.815 -0.597** 0.007 1.429** 0.724* ,065 1 . 8 7(-2.41) (1.56) (-3.25) (0.03) (2.27) (1.76)

Equity REITs -9.335** 5.316** -0.603** -0.095 1.110* 1.040** .I52 1 . 7 7(-2.80) (4.47) (-3.40) (-0.45) (1.82) (2.62)

Govt. Bonds - I.652 -0.747 0.077 0.362** 1.239** -0.332 ,033 1 . 9 0(-0.69) (-0.92) (0.61) (2.41) (2.84) (-1.16)

MCB Stocks -9.494** 3.027* -0.322 0.275 1.497* 0.649 ,030 1 . 6 7(-2.03) (1.92) (-1.29) (0.94) (1.76) (1.17)

NMCB Stocks -9.732** 3.690** -0.402** 0.176 0.934 0.921** ,082 1 . 5 4(-2.86) (3.23) (-2.22) (0.82) (1.51) (2.26)

Small Stocks ~ 12.562** 5.604** -0.841** -0.104 2.014** 1.114** ,133 1 . 7 6(-2.58) (3.42) (-3.30) (-0.34) (2.3X) (2.00)

Regression of the returns on each asset class at time t + 1 on a January dummy, the yield on Treasury hills,the spread between the yield on AAA corporate bonds and the yield on T bills. the dividend yield for the overallstock market, and the cap rate on real estate all at time I. Regression coefticients are given by the first line ofeach TOW, while the f-statistics are given in parentheses in the second row. MCBs stands for money center banksand NMCBs represents nonmoney center banks.* indicates significance level at 10%. ** indicates significance level at 5%.

With respect to the other forecasting variables, the constant is significant for both bankstock return portfolios as is the January dummy (at the 10% level or better). The spreadand dividend yield variables have the expected positive signs but are generally insignifi-cant at the 10% level with one exception-the dividend yield variable in the MCB stocksregression.

The time-varying forecasting variables in Table 2 along with their estimated coefficientscan be used to generate expected excess returns E,[r,,,+,], or conditional risk premiums,for each portfolio. These can be compared to the actual excess returns, i,i+i , on each port-folio. Estimated expected excess returns relative to actual excess return for MCBs are shownin Figure 2. As can be seen, the monthly predictable or forecastable risk premiums onMCBs can be as high as 6% for some months, while actual monthly excess returns varyfrom about -28 % to 20%. Figure 3 plots the expected excess return (risk premiums) forMCBs relative to REITs over 1971:2-1989:4?O Overall, both MCBs and REITs expectedexcess returns move closely in tandem with a high correlation coefficient of 0.868. Therisk premium for the NMCB group exhibits an even closer co-movement with that of theREITs. Figure 3 also provides a supply side explanation to real estate market cycles inthe last twenty years. As we can see from the figure, the gradual reduction of risk premiumfor banks and real estate certainly is consistent with the increase in real estate lending andreal estate development in the late 1970s while the high cost of leading in the recessionsof 1980 and 1981-1982 also offer an explanation as to why larger numbers of U.S. banksadopted a relatively easy credit policy for real estate financing in the later 1980s.


l~~~l~~~l~~~I,,~I,,,l,,,i,,,,,,,I,,,,,,,, ,,,/,I ,,,,,,,,,,,,,,,,,,,,,,,,,,,J72 74 76 78 80 82 8LT 86 88 90

Time Period: 197 1 .2- 1989.4

Figure 3. Conditional risk premium on MCBs and REITs without the January effects.

to 1 for the market portfolio, the betas for both the MCBs and NMCBs are higher thanunity (1.068 and 1.162 respectively) but smaller than that for REITs (pii = 1.525). Asexpected, the beta for the bond portfolio is low. Moreover, the chi-square test of the linearpricing restriction implied by equation 5 could not be rejected by the data at 18.1% level.

The model was then reestimated assuming K = 2 (panel B) and K = 3 (panel C). Thatis, we also estimate a two-factor and a three-factor model. To gain insights into the effectsof the interest-rate factor and the real-estate factor on bank stock returns, we undertooka normalization procedure. Specifically, we normalize the bond portfolio to have a betaof 1 on the first factor and a beta of 0 on the second factor, and we normalize REITs tohave a beta of 0 on the first factor and a beta of 1 on the second factor. Using this normal-ization procedure, the first factor in panel B of Table 3 can be called the bond or interestrate factor, and the second factor the real estate factor, since a given change in these factorswill result in a corresponding change in the relevant portfolios’ asset returns. From panelB, it can be seen that while the MCBs have a greater sensitivity to the interest rate factorthan the NMCBs (0.734 vs. 0.323) over 1971-1989, they are slightly less sensitivity tothe real estate factor (0.665 vs. 0.732). Nevertheless, in this model specification, the real-estate factor is strongly significant for both MCBs and NMCBs. Further, the linear pricingrestriction imposed by equation 5 on the two-factor model cannot be rejected by the datausing a Chi-square test (p = 46.2%).

210 JIANPINC MEI AND ANTHONY SAUNDERS

7?1h/e 3. Estimation of the latent variable model (4) with the rank restriction of equation 5 imposed

E,[C,,+,l =i: &k i: k,x,,, =; Gxntk-l “=I “=I

(4)

A. The number of systematic factors in the economy equals one (K = 1).

P,I S.D.

Estimated beta coefficient for the following assets:Excess return on the market portfolioExcess return on government bond portfolioExcess return on REITs portfolioExcess return on NMCBs portfolioExcess return on MCBs portfolio

&statistic of the rank restriction (5): 25.54 (DF = 20).Significance level: P = 0.181.

1 .ooo*0.083 0.1481.525 0.318I.162 0.1611.068 0.167

B. The number of systematic factors in the economy equals two (K = 2).

P,l S.D. P,, S.D.

Estimated beta coefficient for the following assets:Excess return on market portfolioExcess return on government bond portfolioExcess return on REITs portfolioExcess return on NMCBs portfolioExcess return on MCBs portfolio

1.068 0.442 0.603 0.160I .OOo* o.ooo*o.OOo* - 1 .OOo* -

0.323 0.243 0.732 0.0890.734 0.464 0.665 0.141

X2-statistic of the rank restriction (5): I I .79 (DF = 12)Significance level: P = 0.462.

C. The number of systematic factors in the economy equals two (K = 3).

4, S.D. P,* S.D. P,3 S.D.

Estimated beta coefficient for the following assets:Excess return on market 1.000* - o.OOo* - o.ooo* -Excess return on government bond portfolio o.oOO* - 1.000* - o.OOo* -Excess return on REITs portfolio o.oOo* - o.OOo* - 1.000* -Excess return on NMCBs portfolio -0.461 0.649 0.832 0.624 1.006 0.400Excess return on MCBs portfolio -0.360 0.985 1.099 0.841 0.871 0.587

x*-statistic of the rank restriction (5): 3.16 (DF = 6).Significance level: P = 0.788.

Notes: MCBs stands for money center banks, and NMCBs represents nonmoney center banks. S.D. stands forstandard error for the corresponding parameter estimates. Asterisks indicate these numbers are normalized tobe I or 0. The sample period for this table is 1971:2-1989:4, with 219 observations. The standard errors reportedhere have been corrected for heteroskedasticity using the general method of moments (GMM) of Hansen (1982).


Finally in Table 3, panel C, we present the results of a three-factor model. As in the two-factor case, we normalize the betas on various asset portfolios. Specifically in the three-factor case, we normalize the betas on the stock market, bond, and REIT portfolios so thatwe have a stock factor, a bond factor, and a real estate factor. This allows us to identify theeffects of these three factors on MCB and NMCB portfolio returns. As can be seen thesensitivity of bank stocks to the stock factor is both negative and insignificantly differentfrom zero. The exposure of bank stocks to the interest rate factor is again stronger for theMCBs, although the significance level is lower than in the two-factor model. The strongestfactor, in terms of explanatory power, appears to be the real estate factor. This factor ispositive for both portfolios of banks, but it is larger and more significant for the NMCBgroup.‘* These results appear to confirm our earlier findings in Table 2 with the uncon-strained model, that the real estate factor is more important for NMCBs than for MCBs.

4.2. Subsample Estimates

As a test of robustness, we also split the sample into two subsamples: 1971:2-1979:9 and1979: IO-1989:4. The latter period incorporates a more volatile interest rate environmentas well as a period in which many banks were expanding their real estate portfolios. Bysplitting the sample in this manner, we allow for structural changes in factor sensitivitiesI

For MCBs, the results in Table 4, panel A for the one-factor model suggest an increasein their sensitivity to the market factor in the more recent subperiod (0.975 vs. 0.394).The two-factor model (panel B) implies that while MCBs’ interest rate sensitivity increasedmarginally in the more recent subperiod, their sensitivity to the real estate factor increasedmore dramatically. This probably reflects the fact that the market is increasingly awareof the real estate risk exposure of large U.S. banks. The results for the three-factor model(panel C), generally support the two-factor model conclusions regarding changes in MCBs’real estate factor sensitivity over the two periods. The results for NMCBs generally suggestan increase in sensitivity to all factors in the more recent subperiod.

These results are supported by recent changes in bank real estate holdings. Accordingto Standard and Poor’s Industry Surveys (Industry Survey, Banking Section 1991), U.S.commercial banks has $285.7 billion of real estate loans in 198 1. By 1990, the real estateloans almost tripled to $836.5 billion. In 1991, the ratio of real estate loans to all loanswas 29%. By 1992, the same ratio became 40%!

5. Summary and Conclusions

This paper has sought to examine the ex ante pricing of risk implicit in money center andnonmoney center bank returns. Unlike previous studies that have concentrated on the expost return generating processes of bank stock returns, or have assumed risk premiumsto hold constant over time, we investigate an asset pricing model from which ex ante time-varying risk premiums can be derived.

We find that the time variation in bank risk premiums have been partly determined byinterest rate and real estate market conditions. We also discover that the real estate factor

212 JIANPING MEI AND ANTHONY SAUNDERS

Table 4. Estimation of the latent variable model (4): Two subperiods

A. The number of systematic factors in the economy equals one (K = 1).

PII S.D. @,I S.D.

Estimated beta: 1971:2-1979:9 1979: IO-1989:3Market 1 .ooo* I .ooo*Bonds 0.123 0.120 0.158 0.207REITs 0.729 0.362 1.151 0.182NMCBs 0.848 0.144 0.998 0.142MCBs 0.394 0.289 0.975 0.183

&statistic of the rank restriction (5): 19.40 &statistic of the rank restriction (5): 25.42Significance level: P = 0.495 Significance level: P = 0.185

B. The number of systematic factors in the economy equals two (K = 2)

P,I S.D. PI2 S.D. &I S.D. PI2 S.D.

Estimated beta: 1971:2-1979:9Market 2.743 1.755 0.561Bond 1.000* o.OOO*

REITs o.OOO* 1 .OOO*NMCBs 1.428 0 . 9 8 6 0 . 6 9 0MCBs 0.637 1.088 0.390

&statistic of the rank restriction (5): 11.68Significance level: P = 0.471

1979: IO-1989:30.236 0.211 0.181 0.805 0.135

1.000* o.OOO*o.OOO* 1 .OOO*

0.123 0.213 0.147 0.852 0.0950.187 0.737 0.313 0.931 0.177

X2-statistic of the rank restriction (5): 11.25Significance level: P = 0.507

C. The number of systematic factors in the economy equals two (K = 3)

P,I S.D. 0,~ S.D. Pi3 S.D.

Estimated beta coefficient for the following assets:Excess return on market 1.000* - o.OOo* - o.OOo* -Excess return on government bond portfolio o.OOO* - 1.000* - o.OOo* -Excess return on REITs portfolio o.OOO* - o.OOO* - 1.000* -

Subperiod 1: 1971:2-1979:9 &statistic: 1.76 (P = 0.940)Excess return on NMCBs portfolio -0.593 1.224 3.267 3.193 1.038 0.653Excess return on MCBs portfolio -0.714 1.234 2.931 3.029 0.813 0.631

Subper iod 2 : 1979:10-1989:3 x2-statistic: 1.58 (P = 0.953)Excess return on NMCBs portfolio -0.514 0.583 0.378 0.310 1.218 0.519Excess return on MCBs portfolio -1.041 1.210 1.097 0.643 1.663 1.021

Notes: MCBs stands for money center banks, and NMCBs represents nonmoney center banks. SD. stands forstandard error for the corresponding parameter estimates. Asterisks indicate these numbers are normalized tobe 1 or 0. The sample period for this table is 1971:2-1989:4, with 219 observations. The standard errors reportedhere have been corrected for heteroskedasticity using the general method of moments (GMM) of Hansen (1982).


has been most important for large nonmoney center banksi Moreover, we find that thetime variation of risk premiums is consistent with changes in bank real estate lending dur-ing the sample period.

Acknowledgments

We wish to thank John Campbell for letting us use his latent variable model algorithmand Doug Herold, Wayne Ferson, and Cracker Liu for providing data on real estate caprates, REITs, and business condition variables to us. We are also grateful to Bin Gao forable research assistance. We have benefited from helpful discussion with Mitchell Berlin,Silverio Foresi, and Cracker Liu. We acknowledge financial support from the SalomonCenter at New York University.

Appendix

NameMoney-Center Bank

Date Begin

Bank of Boston Corp 710107Bank New York Inc 691204Bankers Trust NY Corp 6905 16Chase Manhattan Corp 6503 15Chemical Banking Corp 690305Chemical Banking Corp 87052 1Citicorp 681101First Chicago Corp 711230Manufacturers Hanover Corp 690428Mellon Bank Corp 810710Morgan JP & Co Inc 69040 1Republic New York Cot-p 720112

Date End Value (in $1000)

901231 0.469908E+06901231 O.l23442E+07901231 0.350817E+07901231 O.l34632E+O7901231 0.967274E+06901231 0.337990E+05901231 0.419593E+07901231 O.l08930E+07901231 O.l52318E+07901231 O.l04650E+07901231 0.8217lOE+07901231 O.l71384E+07

Nonmoney Center Bank (NYSE & AMEX)Name Date Begin Date End

Amsouth Bancorporation 8 10520 901231Arizona Commerce Bank Tucson 861223 90083 1BBI Inc 620702 730508BSD Bancorp Inc 85 1010 901231Bathe Group Inc 72053 1 810611Baltimore Bancorp 880204 901231Bane One Corp 830929 901231Banctexas Group Inc 811023 901231Bank New England Corp 880412 901231Bank of San Francisco Hldg Co 880712 901231

Value (in $1000)

0.456554E+06O.l54250E+030.989500E+030.242276E + 050.348742E+060.541875E+050.439665E+070.395719E+O40.478074E +05O.l07540E+05


Nonmoney Center Bank (NYSE & AMEX) (continued)Name Date Begin Date End

760628 90123 1791217 90123 1891214 9012317207 17 8203 19890313 90083 1781227 90123 19005 17 9012318807 11 90123 1730910 901231870924 901231710720 901231900629 901231840507 901231880720 901231761201 880419880317 90123 1710517 901231620702 9012318802 16 901231871109 901231720110 900305880801 901231710419 901231710913 901231791227 840117880209 90123184030 1 901231891026 901231861007 901231830527 901231780417 820609860604 900823841121 901231890112 90123173022 1 901231881025 901231621210 901231871021 901231890413 9012317903 14 901231881221 901231710106 901231

Value ($1000)

Bankamerica CorpBarnett Banks IncCVB Financial CorpChase Convertible Fd Boston IncCitizens & Southern Corp GACitizens First BancorpCity National CorpCitytrust Bancorp IncContinential Bank CorpEldorado Bancorp CAEquimark CorpFirst of America Bank CorpFirst Bank Systems IncFirst City Bancorporation TX IncFirst City Bancorporation TXFirst Empire State CorpFirst Fidelity Bancorporation NEFirst Interstate BancorpFirst Interstate BancorporationFirst National Corp CAFirst Pennsylvania CorpFirst Union CorpFirst Virginia Banks IncFirstar Corp NewGuarantee Bancorp IncGuardian Bancorporation LAHUBCO IncHibernia Cot-pJames Madison LtdKeycorpLITCO Bancorporation NY IncLa Jolla BancorpLandmark Bancshares CorpMNC Financial IncNBD Bancorp IncNational City CorpNorwest CorpPNC Financial CorpPacific Western BancsharesSecurity Pacific CorpShawmut National CorpSignet Banking Corp

0.565060E+07O.l18465E+070.647932E+050.717080E+05O.l29093E+070.504474E+050.3886068+060.796500E+040.440972E3060.253036E+050.26577OE+O50.761685E+06O.l00340E+070.845542E+O5O.l89433E+050.361898E+060.1045898+07O.l45206E+070.149504E +050.416981E+050.585003E+06O.l67834E+070.485440E+060.657378E+060.3645348+050.429944E +050.2191928+05O.l81803E+060.9735008+040.983475E+060.957960E+050.725355E+050.390601E+050.280836E+060.240659E+O7O.l89056E+070.209434E+070.2057478+070.983854E+050.251307E+070.3737378+060.275560E+06


Nonmoney Center Bank (NYSE & AMEX) (continued)Name Date Begin Date End

Southeast Banking Corp 720807 901231Southwest Bancorp 850716 891019Southwest Bancshares Inc 760728 841010Sovran Financial Corp 8809 13 90083 1Sterling Bancorp 620702 90123 1Suntrust Banks Inc 850701 901231Texas American Bancshares Inc 820623 890725UJB Financial Corp 701123 901231Union Planters Corp 890207 90123 1Wells Fargo & Co New 700209 901231Westamerica Bancorporation 870108 901231Worthen Banking Corp 830815 90123 1

Value ($1000)

O.l64244E+060.382326E+050.373744E+O60.1583488+070.4505 14E +050.288424E+07O.l38875E+040.319236E+060.117205E +060.297744E+070.828516E+05O.l25706E+06

Nonmoney Center Bank (NASDAQ)Name Date Begin

Affiliated Bankshares Co10 IncAmeritrust CorpAmsouth BancorporationArizona Commerce Bank TuscanBaltimore BancorpBane One CorpBanco Popular de PRBancorp Hawaii IncBanctexas Group IncBank New England CorpBank of San Francisco Hldg CoBank South CorpBankamerica CorpBanks Iowa IncBarnett Banks IncBaybanks IncBoatmens Bancshares IncCVB Financial CorpCentral Bancshares South IncCentral Fidelity Banks IncCitizens & Southern Corp GACity National CorpCitytrust Bancorp IncColorado National Bankshares IncComerica IncCommerce Bancshares IncCorestates Financial Corp

721214 901231 O.l09897E+06721214 901231 0.303639E+06721214 8105 19 O.l71887E+06861002 861222 O.l52932E+05841025 880203 O.l64866E+06721214 830928 0.865059E+06721214 901231 0.321568E+06721214 901231 0.787539E+067704 18 811022 0.603595E+05721214 880411 0.189932E +07860627 8807 11 O.l07278E+05721214 90123 1 0.214331E+06721214 760625 0,388828E+07721214 90123 1 0.205829E+06721214 791214 O.l75601E+06721214 901231 0.204204E+06721214 90123 1 O.l10144E+078303 16 891213 O.l27820E+06721214 90123 1 0.295730E+06721214 901231 0.3798788+06721214 890310 O.l64851E+O7721214 9005 16 0.676099E+06721214 880708 0.200450E+06721214 901231 O.l04377E+06721214 901231 0.702182E+06721214 901231 0.430171E+06721214 901231 O.l72402E+07



Nonmoney Center Bank (NASDAQ) (continued)Name Date Begin

Crestar Financial Corp 721214Cullen Frost Bankers Inc 770708Dauphin Deposit Corp 740405Deposit Guaranty Corp 721214Dominion Bankshares Corp 721214Eldorado Bancorp CA 810318Equitable Bancorporation 721214Fifth Third Bancorp 750423First Alabama Bancshares Inc 721214First Bancorporation Ohio Inc 820104First American Corp TN 721214First of America Bank Corp 780504First Bank Systems Inc 721214First City Bancorporation TX 721214First Commerce Corp New Orleans 721214First Empire State Corp 721214First Florida Banks Inc 721214First Hawaiian Inc 721214First Maryland Bancorp 721214First National Corp CA 821101First Security Corp DE 721214First Tennessee Nat1 Corp 721214First Union Corp 721214Florida National Banks FL Inc 721214Fourth Financial Corp 721214Guarantee Bancorp Inc 721214HUBCO Inc 721214Hibernia Cot-p 721214Huntington Bancshares Inc 721214INB Financial Corp 721214Integra Financial Corp 810115Keycorp 721214LITCO Bancorporation NY Inc 721214Landmark Bancshares Corp 760312MNC Financial Inc 721214Manufacturers National Corp 721214Marshall & Ilsley Corp 721214Mellon Bank Corp 721214Mercantile Bancorporation Inc 721214Mercantile Bankshares Corp 721214Merchants National Cot-p 730924Meridian Bancorp Inc 721214

Date End Value ($1000)

901231 0.430512E+06901231 0.565144E+05901231 0.336757E+06901231 O.l56025E+06901231 0.2625088+06870923 0.229560E-tO5900117 0.437543E+06901231 O.l30119E+07901231 0.581685E+06901231 0.301296E+06901231 0.148608E +06900628 0.841650E+06840504 0.750868E+06761130 0.2979908+06901231 O.l61084E+06880316 0.266084E+06901231 O.l41975E+06901231 0.6335608+0689032 1 0.703596E+06871106 0.2363388+05901231 0.355113E+06901231 0.355439E+06880729 0.253192E+07900126 0.675635E+06901231 0.316931E+06791226 0.3360348+05840229 O.l81125E+0589 1025 0.687808E+06901231 0.651491E+06901231 0.340879E+06901231 0.386272E+06830526 O.l94985E+06780414 0.457710E+05841120 0.3388708+05890111 O.l29424E+07901231 0.688882E+06901231 0.600012E+06810709 0.753109E+06901231 0.341397E+06901231 0.601708E+06901231 0.216706E+06901231 0.4158848+06


Nonmoney Center Bank (NASDAQ) (continued)Name Date Begin Date End

Michigan National CorpMidlantic CorpMultibank Financial CorpNBD Bancorp IncNational City CorpNortheast Bancorp IncNorthern Trust CorpOld Kent Financial Cot-pPNC Financial CorpPacific Western BancsharesPremier Bancorp IncPuget Sound BancorpRiggs National Corp Wash DCSecurity Pacific CorpShawmut National CorpSociety Cot-pSouth Carolina National CorpSouthwest BancorpSouthwest Bancshares IncSovran Financial CorpStar Bane CorpState Street Boston Cot-pSunwest Financial Services IncTexas American Bancshares IncTrustcorp IncTrustmark CorpUnion Planters CorpUnited Banks Colorado IncUnited Missouri Bancshares IncUnited States Bancorp ORUnited States Trust Cot-pValley National Corp AZWest One BancorpWestamerica BancorporationZions Bancorp

Value ($1000)

721214 901231 0.244902E+06721214 901231 O.l90470E+068006 11 901231 0.355221E+05721214 730220 0.292500Ef0673050 1 881024 O.l34692E+07721214 901231 0.375660E+05721214 901231 0.100111E+07770802 901231 0.615426E+06721214 871020 0.255371E+07831102 890412 0.818235E+05850111 901231 0.676858E+05780705 901231 0.299763E+06721214 901231 0.1205498+06721214 790313 0.761228E+06721214 881220 O.l69942E+07721214 901231 O.l0568OE+O7721214 901231 0.354126E+06780802 850715 O.l14538E+05721214 760727 O.l50975E+O6721214 880912 0.194216Ef07721214 901231 0.483874E+06721214 901231 0.1274658+07770803 90123 1 0.1275628+06721214 820622 0.257430E+06730131 900105 0.428558E+06721214 901231 O.l71938E+06721214 890206 0.1973988+06721214 90123 1 0.350532E+06721214 901231 0.338229E+06721214 901231 O.l22172E+07721214 901231 0.283309E+06721214 901231 0.215553E+06741028 901231 0.306672E+06761015 870107 O.l47537E+06721214 901231 O.l90310E+06

REIT (NYSE & AMEX)Name Date Begin Date End

American Fletcher Mtg Invs 701106 77 1202American Health Pptys Inc 870212 901231American Realty Trust Inc 691002 901231Americana Hotels & Realty Corp 830113 901231

217

Value (in $1000)

O.l52lOOE+040.365804Et06O.l16490E+05O.l53750E+05


REIT (NYSE & AMEX) (continued)Name

Angeles Mortgage Investment TrAngeles Participating Mtg TrustArizona Land Income CorpAsset Investors CorpAssociated Mortgage InvestorsBB Real Estate Invt CorpBRT Realty TrustBRE Properties IncBT Mortgage InvestorsBoddie Noel1 RestaurntBradley Real Estate TrustBurnham Pacific Properties IncCR1 Insured Mtg Invs II IncCR1 Insured Mortgage Assn IncCR1 Liquidating REIT IncCV REIT IncCalifornia Real Estate Invt TrCapital Housing Mtg Partners IncCapstead Mortgage CorpCitizens Mortgage Investment TrColumbia Real Estate Invts IncContinental Mortgage InvestorsCopley Property IncCountrywide Mortgage Invts IncDelaware Valley Fin1 CorpDerwood Investment TrustDial REIT IncDuke Realty Investments IncDuke Realty Investments IncEQK Realty Investors 1Eastgroup PropertiesEquitable Life Mtg & Rlty InvsFGI InvestorsFederal Realty Investment TrustFirst Union Real Est Eq & Mg InvGeneral Growth PptysGuild Mortgage Investments IncHMG Courtland Properties LtdHRE PropertiesHarris Teeter Pptys IncHealth Care Ppty Invs IncHealthvest

Date Begin Date End Value (in $1000)

880104 901231 0.292530E+05891115 901231 0.289800E+05880607 901231 0.966OOOE-tO4861219 901231 0.111160E+06700303 73 1026 0.740675E+0485 1025 890717 0.200375E+05730523 901231 O.l74491E+058008 14 901231 O.l82479E+06710318 820618 0.3438508+04870519 901231 0.270750E+05891005 901231 0.208835E+05870604 901231 0.686250E+05860630 891127 O.l06700E+06891207 901231 O.l35972E+06891207 901231 0.368915E+0673032 1 901231 0.216810E+05801229 901231 0.215840E+05890609 901231 0.305148E+05850905 901231 O.l21800E+06710817 760120 0.248675E+0486022 1 901231 0.367579E+05650614 750723 0.2344288+05850719 901231 0.345395E+05850909 901231 0.614025E+05820714 901231 0.777600E+04700128 860115 O.l32559E+05900518 901231 0.565356E+05860317 880815 0.61 lOOOE+O488083 1 90123 1 0.247078E+05850305 90123 1 0.189725E +05730117 901231 0.306862E+05710122 830105 0.838058E-tO57 10430 831208 O.l02878E+05750609 901231 0,240249E+0670052 1 901231 O.l28598E+06730305 850925 0.712598E+05860624 880629 O.l89875E+05720926 90123 1 0.562400E+04700518 901231 0.5868508+05860808 871230 0.219188E+05850523 901231 0.38034lE+06860529 901231 O.l88528E+05


REIT (NYSE & AMEX) (continued)Name Date Begin

Health & Rehabilitation Pptys Tr 861217Health Care REIT Inc 840223Health Equity Properties Inc 861021Highlands National Inc 731128Homeplex Mortgage Investments 88072 1Hotel Investors Trust 720503Hotel Properties Inc 840106ICM Property Investors Inc 850125IDS Realty Trust 73052 1IRT Property Co 711011International Income Ppty Inc 840607Kavanau Real Est Tr 620702Koger Equity Inc 880818Landsing Pacific Fund 881213Lincoln North Carol Rlty Fd Inc 851216Linpro Specified Pptys 860723MGI Properties Inc 720302MIP Properties Inc 85070 1MSA Realty Corp 841001Massmutual Mortgage & Rlty Invs 710113Medical Properties Inc 8703 10Meditrust 870623Metropolitan Realty Corp 881117Mortgage & Realty Trust 7 10503Nationwide Health Properties Inc 851219New Plan Rlty Tr 790307North American Mortgage Invs 690905Northwestern Mutual Lf Mtg & Rlty 710722Nova Corp 731031Novus Properties Co 720428One Liberty Properties Inc 861008Pacific Realty Trust 721219Pennsylvania Real Est Invt Tr 700610Pittsburgh & West Virginia RR 620702Plaza Realty Invs 730524Presidential Realty Corp New 620702Presidential Realty Corp New 620702Property Capital Trust 720906Property Trust Amer 890627Prudential Realty Trust 851001REIT America Inc 710416RPS Realty Tr 881228

Date End Value ($1000)

901231 O.l33983E+06901231 0.8248368+05901231 0.204960E+05750609 0.382362E+04901231 0,423281E+05901231 O.l36485E+05860915 0.7584OOE+05901231 0.216630E+05761216 0,451688E+04901231 0.912102E+05900626 0.309983E-tO676052 1 O.l45622E+O4901231 O.l12620E+06901231 0.4754628+05901231 O.l04895E+05901231 O.l04400E+04901231 0.693029E-tO5901231 O.l46575E+05901231 0.291836E+05850625 O.l21420E+06901231 O.l12528E+05901231 0.388482E+0690123 1 O.l86945E+05901231 0.263055E+O5901231 O.l95912E+06901231 0.601961E+06810519 O.l63899E+05821115 0.654225E+05750930 0.241600E+047404 18 0.1766758+05901231 0.887088E+O4830215 0.382500E+O5901231 O.l24373E+0690123 1 0.887125E+04760616 0.1531758+04901231 O.l97588E+04901231 0.856800E+04901231 0.627491E+0590123 1 0.354970E+05901231 O.l73984E+04841213 0.923449E+05901231 O.l54096E+06

219


REIT Bank (NYSE & AMEX) (continued)Date Begin Date EndName

RampacReal Estate Investment Tr AmerReal Estate Investment Trust CARealty Refund TrResidential Resources Mg Invt CpResidential Mortgage Invts IncResort Income Invs IncRockefeller Center Pptys IncRymac Mortgage Investment CorpSaul BF Real Estate Invt TrSierra Capital Realty Trust VIIISizeler Property Investors IncStorage Properties IncStorage Equities IncStrategic Mortgage Invts IncTIS Mortgage Investment CoTrammel1 Crow Real Estate InvsTranscontinental Realty InvstrsTransamerica Realty InvestorsTRI South Investors IncTurner Equity Invs IncUSP Real Estate Investmt TrustUnited Dominion Realty Tr IncUnited Realty Investors IncUnited States Realty InvtsUniversal Health Rlty Incm TrWachovia Realty InvestmentsWashington Real Est Invt TrWeingarten Realty InvestorsWedgestone FinancialWells Fargo Mortgage & Equity TrWestern Investment Real Est TrWincorp Realty Invts

Value ($1000)

800417 840123 O.l18184E+06620702 831004 0.640952E+05870819 901231 0.9236258+05721121 901231 O.l34006E+05880624 890316 0.2799388+04860616 901231 0.896750E +04881025 901231 0.327285E+05850912 901231 0.712690E+06880916 901231 0.3604568+057307 10 880817 0.147436E +06900727 901231 O.l02064E+05870130 901231 0.290568E+05901001 90123 1 0.1850068+05821001 901231 0.760351E+05841212 891106 0.6967888+05880819 901231 0.546750E+05851121 901231 0.226875E+O5860910 901231 O.l22760E+05710719 860930 0.383952E+05720530 850415 0.3693808+05850719 881221 0.304020E+05880810 901231 O.l11550E+05900507 901231 O.l73041E+067206 19 831026 0.5433008+05680226 821223 0.344158E+05870120 901231 0.766361E+05710128 820318 0.250125E+05710507 901231 0.2593408+06850816 901231 0.408202E+06851001 901231 0.362188E+04720425 891222 0.925925E+O4840613 901231 0.2333208+0677 1004 841207 0.581030E+05

REIT (NASDAQ)Name Date Begin

API Trust SBI 721214American Equity Invt Tr 740524Americana Hotels & Realty Corp 821104Arlington Realty Investors 721214Bradley Real Estate Trust 850517Burnham Pacific Properties Inc 870105


830414 0.417000E+O48409 13 0.596159E+05830112 O.l23714E+06880503 0.998000E+03891004 0.3822OOE+05870603 0.238560E+05


REIT (NASDAQ) (continued)Name

CPL Real Estate lnvesmtne TrCV REIT IncCedar Income Fund LtdCedar Income Fund 2 LtdCentral Realty Investors IncCentrevest CorpChicago Dock and Canal TrustCitizens Growth PptysClevetrust Realty InvestorsCommonwealth Fin Gp Rl Es Inv TrCommonwealth Realty TrContinental Mortgage & Equty TrCousins Properties IncDelaware Valley Fin1 CorpDenver Real Estate Invt AssnDial REIT IncDominion Mortgage & Realty TrustEastover Cot-pFirst Fidelity Investment TrustFlatley Realty InvestorsFlorida Gulf Rlty TrGeneral Real Estate ShsGrubb & Ellis Rlty Income TrHealth Care REIT IncHighlands National IncHotel Properties IncIndependence Mortgage TrustInternational Income Ppty IncJMB Realty TrustLandsing Institutional Ppts Tr VLincoln InvestorsMYM Liquidating TrustMaxxus IncMeditrustMellon Part Mtg Tr Corn1 PptysMerry Land & Investment Co IncMiller Henry S Rlty TrMonetary Realty TrustMonmouth Real Estate Invt Cot-pMurray Mortgage InvestorsNationwide Real Estate InvestorsNooney Realty Trust Inc

Date Begin Date End Value ($1000)

851220 880205 O.l23761E+05721214 730320 0.000000E+00861217 90123 1 O.l04805E+05881021 890929 0.6237OOE304721214 901231 0.341031E+03861107 880715 0.433838E-tO4861021 901231 0.6507OOE+05721214 901231 0.259875E+O4721214 901231 0.3946OOE+04721214 90123 1 0.5355948+037403 13 8803 11 0.227540E+05821018 901231 0.1645588+05721214 901231 0.1733708+06730209 820713 0.203712E+05721214 801222 0.401865E+05861219 900517 0.771690E+05721214 8602 13 O.l97635E+05730302 901231 0.629200E+04721214 781109 0.941775E+04810615 810902 0.9625OOE+O4730504 851210 0.600064E+05721214 901231 0.423438E+028504 19 901231 O.l16OOOE+05780217 840222 0.257118E+05721214 860430 O.l20478E+05760430 840105 O.l48046E+05721214 770808 0.703125E+03791218 840606 0.859275E+05801128 90092 8 0.7115OOE+04850422 881125 O.l21560E+05721214 820308 0.228312E+04901204 901231 0.2593268+05731218 850116 O.l00462E+0585 1009 870622 0.217100E+O68502 13 901231 0.389025E+058 10706 901231 0.358554E+05721214 821223 O.l40OOOE+05721214 821130 0.780000E+03721214 901231 0.898625E+O473062 1 840608 0.100600E+04721214 8 10220 O.l68829E+05851015 901231 0.780300E+O4

221

A


REIT (NASDAQ) (continued)Name

Nova CorpNovus Properties CoOne Liberty Properties IncPacific Southern Mortgage TrustPlaza Realty InvsProperty Trust AmerRainier Realty InvestorsReal Estate Investment Trust CAResources Pension Shs 3Resources Pension Shs 1Resources Pension Shs 2 TrRiverside Properties ILSaul BF Real Estate Invt TrSierra Real Estate Equity Tr 84Storage Equities IncTerrydale Realty TrustTowermarcTravelers Real Estate Invt TrTravelers Realty Income InvsUSP Real Estate Investmt TrustUnicorp Realty Investors IncUnited Dominion Realty Tr IncUnited States Equity & Mtg TrUnited States Mutual Fin1 CorpVanguard Real Estate Fund IIVinland Property TrustVirginia Real Estate Invt TrWMI Equity InvsWedgestone FinancialWespac Investors Trust IIWespac Investors Trust III

Notes

Date Begin Date End Value ($1000)

721214 830630 O.l37918E+05770628 861103 0.457875E+05830425 861007 0.243971E+O5730409 820701 0.735OOOE+04771104 840918 0.922281E+04721214 890626 0.5124268+05850412 8707156 0.3209758+05840823 870818 O.l16960E+06850606 88 1227 0.546411E+05821126 881227 0.435705E+05831223 881227 0.593060E +05721214 90123 1 0.547250E+03721214 730709 0.000000E+00850513 901231 O.l03849E+05801118 820930 0.294548E+05730403 820111 O.l85288E+O4721214 841031 0.110775E +05840426 890330 0.207359E+0585032 1 890330 0.237185E+05780425 901231 O.OOOOOOE+00721214 811102 0.750375E +048002 11 900504 O.l79816E+06721214 770404 0.571050E+O4800307 86082 1 O.l4623lE+04900807 901231 0.416250E+057606 11 901231 0.745750E+03721214 810202 0.215680E+05721214 811013 0.414150E+04821013 850930 O.l62049E+05831212 880622 0.170888E-tO485 1003 880412 0.545912E+04

1. It is possible that the conditional expectation could be nonlinear in the forecasting variables. In that case,equation 3 could be thought of as a Taylor first-order approximation to the nonlinear relationship.

2. A constant is also included.3. Although Flannery and James (1984) model the portfolio mismatch of banks using the repricing structure

of assets and liabilities, their results are consistent with such a duration mismatch.4. See Campbell (1987), Keim and Stambaugh (1986) for mean reversion.5. Liu and Mei (1992) found that the cap rate is useful in explaining the time-variation in real estate expected

returns. Mei and Liu (1994) also discovered that the cap rate can be used in market timing of investmentin real estate portfolios. Because the large holdings of real estate loans in bank portfolios, it would be inter-esting to see how the cap rate would explain the risk premium in bank stock returns.


6. They are Bank of New York, Bankers Trust, Chase Manhattan, Chemical Bank, Citicorp, ManufacturersHanover, J.P. Morgan, Republic New York, Bank of Boston, First Chicago, Continental Bank. The definitionfollows that of Salomon Brothers Commercial Bank Stock Research (various issues).

7. The positive correlation between bond returns and bank stock returns is consistent with a negative correlationbetween interest rates and bank stock returns. (See also, Flannery and James, 1984).

8. The small stock returns series are takn from Ibbotson and Associates’ Stocks, Bonds, Bills, and Inf7ation(SBBI) series on CRSP.

9. This result should not be surprising given the problems of regional banks (such as the Bank of New England)in the Northeast and California.

10. These results are wirhour the January effects.II. See Campbell (1987), Ferson (1989, 1990). and Liu and Mei (1991).12. It is worth noting that the three factors we choose may not be orthogonal. Thus, it is possible that some

of the fundamental forces that move the stock factor also move the real estate factor. Therefore, it is notcontradictory to see bank stocks having exposure to market risk in the one-factor model but little such expo-sure in a three-factor model, since some of the variations in stock returns originally explained by the stockfactor are now explained by the real estate factor.

13. The subperiod 1979:10-1982: 10 (the regime of nonborrowed reserve targets) was too short to include asa separate subperiod in these tests.

14. To test the robustness of our results, we also conducted similar tests on excess returns for a portfolio of tenbanks with the largest commercial real estate loans holdings (as defined by Barrens as of December 1990).The results are quite similar to those of MCBs.

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