THRIFT ASSET-CLASS RETURNS AND THE EFFICIENT DIVERSIFICATION OF THRIFT INSTITUTION PORTFOLIOS

We estimate quarterly return series from March 1984 through December 1 989 for 10 classes of thrift assets using the statistical cost-account ing methodology of Hester and Zoellner (1966). We then use these retur n series to estimate mean-variance efficient frontiers for all thrifts , for thrifts that were well capitalized two years earlier and for thr ifts that were insolvent two years earlier. Our results show that neit her the asset restrictions existing before nor those in effect after p assage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 would have prevented thrifts from reaching most of the por tfolios along the efficient frontier. The actual portfolio chosen by w ell-capitalized thrifts is close to the estimated efficient frontier, while the actual portfolio chosen by insolvent thrifts is located far from the frontier in the high-risk end of investment space. These find ings, coupled with the high proportion of nontraditional assets in the actual portfolio chosen by insolvent thrifts, support the hypothesis that moral hazard induced thrifts to take on investments that were exc essively risky from the deposit insurer's point of view.