A MARKET-BASED RISK CLASSIFICATION OF FINANCIAL INSTITUTIONS

In this article we derive, estimate, and analyze a multifactor model o f the monthly holding period returns on the stocks of exchange-traded financial institutions. In addition to bond and equity returns, the fa ctors include default, liquidity, and term structure risk premiums pin s variables that measure changes in deposit demand. To ensure that our sample has a large number of firms, we use data from January 1981 thr ough December 1988. The equity return explains a large share of time-s eries variation in financial institutions' returns. The additional fac tors implied by theory have little incremental explanatory power. The two-factor model regression coefficients have considerable cross-secti onal variation. This permits us to group intermediaries into portfolio s with similar risk exposures. These portfolios bear no relation to th e SIC codes that group intermediaries by their charters and lines of b usiness.