Size Anomalies in U.S. Bank Stock Returns: A Fiscal Explanation

Abstract

The largest commercial bank stocks, measured by book value, have significantly lower risk-adjusted returns than small- and medium-sized bank stocks, even though large banks are significantly more levered. We find a size factor in the component of bank returns that is orthogonal to the standard risk factors. This size factor, which has the right covariance with bank returns to explain the average risk-adjusted returns, measures size-dependent exposure in banks to bank-specific tail risk. The variation in exposure can be attributed to differences in the financial disaster recovery rates between small and large banks. A general equilibrium model with rare bank disasters can match these alphas in a sample without disasters provided that the difference in disaster recovery rates between the largest and smallest banks is 35 cents per dollar of dividends.