Three Essays in Financial Intermediation

Abstract

This thesis contains three chapters on financial intermediation. Chapter 1 considers whether the rating gap between “all-in” and “stand-alone” ratings for a bank can serve as a good measure of systemic risk, which is defined as the risk that a distressed bank may bring to the banking system. The gap between the stand-alone rating and the all-in rating is attributable to the external support that the bank would receive if it were in financial distress. With the motivation to provide a reliable and easily constructed systemic risk indicator, Chapter 1 contributes to the literature in providing several ways to calculate the rating gap and studies the link between it and a quantitative systemic risk measure, Co-independent Value at Risk (CoVar). This chapter finds that the rating gap is a good proxy for systemic risk for large banks. Chapter 2 evaluates how the risks associated with mergers and acquisitions (M&As) affect banks' levels of solvency. This chapter hypothesizes that bank solvency is affected by M&As directly and indirectly through banks’ market risk, geographical diversification and activity diversification. The relationship between bank solvency, diversification and market risk are estimated as a system using Generalized Method of Moments (GMM). The key finding is that M&As erode banks' solvency, both directly and indirectly through the effects associated with their geographical diversification. Chapter 3 explores whether banks pursue different diversification strategies in response to time-varying market betas and spillover effects during upturns and downturns in markets. The main findings are: 1) banks use different diversification strategies in response to market movements conditional on market stability; 2) banks may need to consider market spillovers in activity diversification plans because spillovers change the link between activity diversification and a bank’s return.