African Journal of Business Management Vol. 5(32), pp. 12624-12631,14 December, 2011 Available online at http://www.academicjournals.

org/AJBM DOI: 10.5897/AJBM11.2220 ISSN 1993-8233 ©2011 Academic Journals

Full Length Research Paper

Stochastic dominance approach of analysis for stock market valuation of financial consolidation in Taiwan
Yuan Chang1* and Hooi Hooi Lean2

Department of Business Education, National Changhua University of Education, Taiwan, Republic of China. 2 School of Social Sciences, Universiti Sains Malaysia, Malaysia.
Accepted 20 September, 2011

To examine whether stock market values financial consolidation in Taiwan since 2002, this paper compares the stock market performance of financial-holding-company banks (FHC-bank) with independent banks using Taiwan’s daily data from 2003 to 2009. While the ultimate goal of a typical public-traded bank is to maximize its stockholder’s wealth, based on stock returns distribution, we employ stochastic dominance (SD) approach to examine relative performance between FHC-banks versus independent banks. The advantage of SD approach is that it lightens the problem that can arise if the asset returns are not normally distributed because it utilizes the whole distribution of returns. Since SD is nonparametric, SD tests do not require any specific assumptions on investors’ utility function or the returns distribution of asset and thus avoid the joint test problem inherent in the standard approach. Most of our evidence shows that there is little dominance in stock returns of FHCbanks relative to independent banks. Thus, Taiwan’s stock market does not value financial consolidation during our sample period. Key words: Financial-holding-company banks (FHC-banks), independent banks, stochastic dominance.

INTRODUCTION Following the trend of financial liberalization around the globe, Taiwan’s government lifted the long-standing restrictions on the establishment of financial institutions in 1988. The Banking Act was amended in 1989, which permited new entrants into the banking industry. Several new and private banks joined banking markets but consequently resulted in overbanking problem in domestic financial market. Obviously, the consequence of abundant entrants leaded to cut-throat competition and then has seriously worsened the overall financial conditions of all banks. According to the Taiwan Ministry of Finance, overall nonperforming loan ratio climbed from around 3% at the end of 1995 to a highest record of 8.78% in March 2002. The banking sector in Taiwan suffered from increasing non-performing loans and decreasing profitability duo to deregulation in 1989. In order to alleviate the overcompetition of banks and elevate the financial system to a new stage of competitiveness in global financial markets, Taiwan government decided to conduct banking financial reforms before millennium. Almost at the same time, in the United States, the announcement of the Citigroup merger in 1998 sped up the process of financial consolidation, and afterwards the Congress passed the Gramm-Leach-Bliley Act (GLBA) in 1999. Through the roof of Financialholding-company banks (FHC), a financial institution can engage in banks, insurances and securities at the same time. The GLBA in U.S. encourages the financial regulators in Taiwan government to speed up the financial consolidation reforms. In 2000, Taiwan passed the amended Banking Law and the Financial Institutions Consolidation Law, while in 2001, FHC Act was stipulated to encourage the consolidation within and cross banking sectors. The FHC holds atleast 25% shares of banks, insurance and

*Corresponding author. E-mail: Tel: 886-920-671950. Fax: 886-49-2390387. JEL classification: C14, C21, G21

Although their focus is not financial 1 Shen (2002) described the advantages and disadvantages of banks being subordinated to FHC and independent. (1997) argue that the benefits of diversification are less than the costs. Rose (1989) suggested that banks engaged in non-bank product lines will reduce cash flow risk. Jensen (1986) proposed that insiders have incentives to expand the range of financial activities if this diversification enhances personal advantages or extract private benefits from the financial institution.Since the passed of FHC Act. and securities is possible. and European banking markets. (1993) and Pulley and Humphrey (1993). In the early stage. 1994. Secondly. hoping to create economies of scale and scope to save cost and improve performance of consolidated banks. Similarly. subordinated to financial holding company (FHC-bank thereafter) outperform a bank to be stand-alone (independent bank thereafter)? This is a greatly-concerned issue by government decision makers and academic researchers. Also. this is the first motivation for our paper. insurance. brokerage and mutual fund services and other activities can produce additional information that improve loan making decisions. Saunders and Walter. Gande et al. (1987) and Berger and Humphrey (1991) provided little evidence of large economies of scope by estimating the trans-log cost function of banks. such as insurance or underwriting of securities (Diamond. institution. Shen (2002) examined CAMEL indicators of 50 FHC-banks and 44 independent ones in U. A bank should focus and take the maximum advantage of managing expertise and thus reduce agency problems. especially since the passage of the Financial Holding Company Act in 2001 to reconstruct financial hierarchy in Taiwan. Cerasi and Dal-tung (2000). especially.S between 1997 and 1998. For examples. Templeton and Severiens (1992) found that banks with diversification among other financial services will reduce their unsystematic risk. Puri (1996). does a bank. For example. and Schenone (2004) found the results of banks which make loans to a firm and underwrite its securities will sell securities to the public at inflated prices to subsidize their lending operations. some independent-banks are specialized in credit card or custodian business and then join the FHC has no particular advantages for them. banks in financial conglomerate. probably because the banks with similar assets size in and not in FHC are rare. Stiroh (2004) showed that noninterest diversification is negatively related to banks performance. Thus. recent alarmed financial tsunami shows that banks with higher and aggressive diversity could increase risks and result in worse performance. conflicts of interest and agency problems have adverse implications on the performance or market’s valuation of a bank.S. banks performance comparisons . On the contrary. The number of empirical studies comparing the performance of FHC-bank and independent bank is rare. similar with the results of Ferrier et al. because of 3C (cross-selling. (1999) showed that higher financial service consolidation drives greater diversification of risk. 1991. empirical test about whether this policy improve stockhoder’s wealth is also needed. an alternative view suggests that independent banks may have specialization advantage 1 and lower systematic risks. Diamond (1984). Therefore. While numerous studies are concentrated on U. and Boyd and Prescott (1986) suggested that banks could achieve credibility in their role as screeners or monitors of borrowers through diversification. They found that FHCbanks outperform independent-banks before and after passage of FHC Act. and Acharya et al. and this gap widens after passage of that Act. thus supported that FHC-bank is superior because banks that engage in deposit-loan activity can facilitate the efficient provision of other financial services. 2002). the service of one-stop shopping from banking. Servaes (1996). leaving the Asian emerging economies such as Taiwan (with relative importance in stock market Asia) passed over. On the contrary. Thus. Rajan. cost down and capital down). and Denis et al. securities and insurance underwriting. could enjoy economics of scale and scope that boost performance and market valuations. Therefore. (1997. Berger et al. Other studies examine the effects of conflicts of interest when a bank both makes loans and sells its securities. there are now a total of 17 FHC-banks and 17 independent banks in Taiwan. Kroszner and Rajan (1994). 1992. Ramakrishnan and Thakor (1984). Theoretically. (2006) suggested that there are diseconomies of scope that arise through weakened monitoring incentives and a poorer quality loan portfolio when a risky bank expands into additional industries and sectors. Although the backdrop and thus the presupposition of Taiwan’s financial reform are based on the conventional wisdom in banking literature which argues that banks could reduce their risks and improve performance through diversification. Hsu and Chang (2005) studied the influence of passage of FHC Act on bank operational efficiency in Taiwan. Boyd and Graham (1988) found banks which are merged with insurance companies have lower risk of bankruptcy. 13 banks joined the FHCs. Laeven and Levine (2007) found that financial conglomerates engaging in multiple lending activities have lower market value than they would if they were split into separate financial institutions. independent bank could have lower systematic risk because a FHC-bank with diversified activities will reinforce agency problem between insiders and outsiders. an additional four banks joined in. DeYoung and Roland (2001) found that U. Jensen (1986). Berger et al. Also.Chang and Leann 12625 securities. Stein. the former outperform the latter. For examples. Later on. under framework of financial holding company. Berger and Ofek (1995). and found that on average. 14 FHCs are established successively. 1999).S banks with lower traditional lending activities and higher fee-based activities have higher revenue volatility and thus risks.

Whitmore (1970) introduced stochastic dominance (SD) theory to economics research.SUN Commercial Bank. (4) First Commercial Bank. independent-banks. In our sample period from 2003 to 2009. (6) Taishin International Bank. In order to get complete financial information about banks. Finance Holding Company Act passed in 2001 and 14 domestic financial holding companies were established successively in Taiwan. we need an ex post evaluations of the policy impacts of the change in legislation and regulatory environment of Taiwan’s banking industry. which might provide an exogenous motive for banks to diversify and thus impacts on their stockholder’s wealth.SUN Commercial Bank Taishin International Bank Mega International Commercial Bank China Development Industrial Bank Chinatrust Commercial Bank Taipei Fubon Bank Chiao Tung Bank Fuhwa Commercial Bank Jih Sun International Commercial Bank International Bank of Taipei Grand Commercial Banks Fubon Commercial Bank Cathay Bank Source: website of Financial (http://www. Hanoch and Levy (1969). SD tests do not require any specific assumptions on investors’ utility function or the returns distribution of asset and thus avoid the joint test problem inherent in the standard approach. SD rankings also have direct interpretations in terms of expected utility and thus provide an appealing basis to relate investors’ revealed preferences to their risk attitudes (Fong.S Financial Services Modernization Act (Gramm-Leach-Bliley Act) for removal of separation prohibition of banking and investment (Glass-Steagall Act) to strengthen financial industry. overall health of the banking system quickly decreased. dates of approbation for establishment. The basic principle underlying SD grounds on the maximization of expected utility.12626 Afr. Executive Yuan Supervisory of various existing papers are not based on stockholder’s wealth. the goal is to maximize its stockholder’s wealth based on stock returns distribution. since SD is nonparametric. 2009). Manage. such as liberalization for bank branch expansion in 1984. Thirdly. date of open for business and banks subordinated to each of the 14 financial holding companies. (3) Cathay United Bank. J. However and unfortunately. Bus. BRIEF ACCOUNT OF FHC IN TAIWAN Wheelock (1993) suggested that the overdevelpoment of banking is more responsibile than any other factos for the banking disaters. Independent banks Hsinchu International Bank Taichung Commercial Bank Tainan Business Bank Taitung Business Bank EnTie Commercial Bank Farmer Bank Taiwan Corporative Bank Chang Hwa Bank Bank of Overseas Chinese Cosmos Bank Pan Asia Commercial Bank Bank of Kaohsiung Union Bank of Taiwan Chinese Bank Far Eastern International Bank Taiwan Business Bank Ta Chong Bank Commission. and Rothschild and Stiglitz (1970). FHC-banks First Commercial Bank Hua Nan Commercial Bank Cathay United Bank Bank SinoPac E. overbanking problem soon emerged. 13 banks are subordinated to financial holding companies. As Taiwan’s first financial reform proposed by President Chen. near a decade after FHC Act. Table 1 summarizes the names. This paper investigates the stock performance with the SD approach between FHC-banks and independent banks in Taiwan Stock Exchange (TWSE). (2) Hua Nan Commercial Bank. thus our paper are based in stock markets performance comparisons to analyze relative performance between FHC-banks versus independent (7) International Commercial . Taiwan started to deregulate its financial For a typical public-traded company. removal of interest rate control in 1985 and policy reform for introduction of newly-establish banks. (5) E. Moreover. which are (1) Bank SinoPac. Table 1. as Wheelock (1993) said. Based on Hadar and Russell (1969). we collect data of banks which are Taiwan Stock Exchange listing companies. FHC-banks vs. Starting from the middle of 1980's. An advantage of this approach is that it lightens the problems that can arise if the asset returns are not normally distributed because it utilizes the whole distribution of returns.fscey. the government referred to U.

(1992) . the problems of asset returns not normally distributed can be minimized. (15) Far Eastern International Bank. …. McFadden (1989). the former is eliminated and former is the surviving bank but the merged bank is re-named as Cathay United Bank.3 . (4) Taitung Business Bank.G j = 1. Klecan et al. Defined as: T j ( x) (j = 1. denoted F3 ( x ) ≤ G3 ( x ) for all possible return x. (10) Cosmos Bank. f and g are the corresponding probability density functions (PDF) respectively. As noted by Levy (1992. (16) Taiwan Business Bank and (17) Ta Chong Bank. although there are 17 independent banks and 14 FHC listing on Taiwan Stock Exchange (TWSE). 2. they are named as F1. the reverse is not true. N ( j − 1)! i =1 N  1  1 2( ˆ ˆ VHj ( x) =  ( x − hi ) + j −1) − H j ( x) 2  . we have their data from 2002Q1 (first quarter of 2002) to one quarter before effectiveness of consolidation. F13. TSD assumes that the risk averse investor has decreasing absolute risk aversion (DARA). (6) Farmer Bank. (LMW. (2) Grand Commercial Bank. For the 5 independent banks. Prospect Y dominates prospect Z at third-order. Y and Z with CDFs F and G respectively and with a grid of pre-selected points x1. 1998). it is denoted as Y f1 Z if and only if F1 ( x ) ≤ G1 ( x ) . x2… xk. there are no specific assumptions on investors’ utility function when employing SD test. In addition. Wong and Zhang (2008) reported that DD test is powerful and less conservative in size. z. ˆ H j ( x) = N 1 ∑ ( x − hi )+j −1 . Furthermore. For the 13 FHC banks. SSD and TSD respectively.and third-order SD denoted by FSD. The sample period of study is from January 2. Rothschild and Stiglitz (1970) and Whitmore (1970) lay the foundation of SD analysis. consequently. h = y. If all non-satiated investor prefer the distribution of stock return of a FHC bank to the independent bank. (9) Chinatrust Commercial Bank. I2. the order-j DD test statistics. The basic principle of SD is grounded in maximizing expected utility. For any two prospects. Hadar and Russell (1969). which in turn implies TSD. Z ( x) =  ∑ ( x − yi )+j −1 ( x − zi )+ − Fj ( x)G j ( x) N  N (( j − 1)!) 2 i =1  where Fj and Gj are defined in (1). (3) Fubon Commercial Bank. DD test is flexible if the series being examined is dependent. (13) Union Bank of Taiwan. denoted F2 ( x ) ≤ G2 ( x ) . (11) Pan Asia Commercial Bank (renamed as Bowa Bank 2005Q2). (9) Bank of Overseas Chinese. merged with Taipei Bank merged into Taipei Fubon Bank and the former is eliminated and (4) Cathay United Bank. Suppose an investor is choosing between two risky prospects Y and Z. (2) Taichung Commercial Bank. or in other word he prefers positive skewness. (14) Chinese Bank. (5) EnTie Commercial Bank. H = F . Since SD approach utilizes the whole distribution of returns. Tse and Zhang (2004) and Lean. (12) Fuhwa Commercial Bank. Barrett and Donald (2003) and Linton et al. Moreover. For these 4 banks subordinated to financial holding companies. G. however. F2. 2 ∑ N  N (( j − 1)!) i =1  N  1 1 j −1 ˆ ˆ ˆ VYj. FSD implies SSD. hierarchical relationship exists in SD. Under FSD criterion. There are 4other banks which are defined as FHCbanks but go through consolidation during our sample period : (1) International Bank of Taipei. the dominated asset would not be chosen. 2003 to December 25. second. we say that prospect Y dominates prospect Z at first-order. During our sample periods. 2009. H0 = h and and H j ( x ) = ∫ H j −1 ( t ) dt x a for h = f. Mathematically. let F and G be the cumulative distribution functions (CDF) and. Kaur et al. Davidson and Duclos (2000). which are merged with United World Chinese Commercial Bank in 2003Q4. Anderson (1996. independent banks are: (1) Hsinchu International Bank. Thus. (1991). (8) Chang Hwa Bank. There are statistical tests for SD which have been well developed. we name it as I1. merged into Chinatrust Commercial Bank in 2003Q4. for example. 2004). (11) Chiao Tung Bank. all investors are non-satiation which means investor prefers more to less. (10) Taipei Fubon Bank. If the CDF of Y’s return is below Z’s for all values. Bishop et al. We choose to use DD test in this study because Wei and Zhang (2003). We use a nonparametric approach based on stochastic dominance (SD) to compare the stock return between FHC banks and independent banks. g . Hanoch and Levy (1969). 2005).Z ( x). Prospect Y dominates prospect Z at second-order. then risk compensation is unlikely to be an explanation for the profitability of FHC banks. …. which are consolidated into Sinopac Holdings in 2005Q2. The existence of SD implies that the expected utility of the investor is always higher when holding the dominant asset than holding the dominated one and. (1) The most commonly-used SD rules that correspond with three broadly defined utility functions are first-. Y f3 Z if and only if DATA AND METHODOLOGY As aforementioned. (1994). (3) Tainan Business Bank (renamed as King’s Town Bank in 2006Q1). SD rankings have direct interpretations in terms of expected utility. regardless his risk preference. (12) Bank of Kaohsiung.Chang and Leann 12627 Bank of China. (13) Jih Sun International Commercial Bank. This can avoid the joint test problem intrinsic in the standard statistical testing approach. SSD assumes that the Y f2 Z if and only if non-satiation investors are risk averse. I5. (8) China Development Industrial Bank. which includes the recent global financial crisis. H = F. 2 and 3) is formulated as: ˆ ˆ Fj ( x ) − G j ( x ) ˆ V j ( x) (2) T j ( x) = ˆ ˆ ˆ ˆ V j ( x) = VYj ( x) + VZj ( x) − 2VYj. complete daily data of stock returns is collected from Taiwan Economic Journal (TEJ) for only 5 independent banks and 13 FHCbanks listed in TWSE. which merged into (7) Taiwan Corporative Bank in 2006Q2.

In general. i = 1. the test statistic at each grid point is computed and the null hypothesis is rejected if the test statistic is significant at any grid point. the number of cases that FHC bank dominates independent bank (15 cases) are approximately equal to the number of cases that FHC bank is dominated by independent bank (14 cases). arbitrage opportunity can exist and any non-satiated investor will be better off if s/he switches from the dominated prospect to the dominant one. 1986. their average standard deviation is lower as well (2. (2007) and Wong et al. Then. (2005).α is used to control for the probability of rejecting the overall null hypotheses. respectively).or third-order. The following decision rules are adopted based on 1-α percentile of and Ury (1979): k If T j ( xi ) < M ∞ . Under the null is asymptotically distributed as the Studentized Maximum Modulus (SMM) distribution (Richmond. denoted by M ∞ . . In other word. Bus.α for some i. arbitrage opportunity does not exist and switching from one prospect to another will only increase investors’ expected utilities. To make more detailed comparisons without violating the independence assumption. To implement the DD test. The DD test results are summarized in Table 3.0491 and 0.0283%. This is consistent with the literature such as Boyd and Graham (1988). both HA is set to be exclusive of H A1 and H A 2 . Hence. a particular prospect stochastically dominates the other at second. k k if − T j ( xi ) < M ∞ . Fj ( xi ) > G j ( xi ) for some xi . DD showed that Tj ( x ) HA is accepted. On the other hand.α for all i and T j ( xi ) > M ∞ . If the FHC-bank stochastically dominates the independent bank at order-j. there will not be any significantly positive Tj but there will be some significantly negative Tj.α for some i. EMPIRICAL RESULTS Table 2 reports the descriptive statistics of the stock returns for independent and FHC-banks during sample period. (2008) for the reasoning. Lean et al. Falk and Levy. accept H A1 . k . We can observe some domination for individual bank. DD test compares the return distributions at a finite number of grid points. being a FHC-bank does not bring any obvious advantages on stock market performance in term of motivate a risk-averse investor’s preference to buy its stock. we conclude that FHC banks are better off than the independent banks from the descriptive statistics and mean-variance criterion. Based on the mean-variance criterion. if H A1 or H A 2 of order one is accepted. accept H A2 . higher Sharpe ratio of FHC-banks than independent banks (0. if H A1 or H A2 is accepted for order two or three. k k M ∞ .. proposed to test the null hypothesis for a pre-designed finite numbers of values x.α tabulated by Stoline Accepting either H0 or HA implies non-existence of any SD relationship. H A1 : Fj ( xi ) ≤ G j ( xi ) for all xi .. Because all the banks have positive daily mean return. based on their stock return during the sample period. To do this. Rose (1989) and Templeton and Severiens (1992) which show evidence that diversified banks are with lower risks. which means that if either H A1 or H A2 is accepted. neither FHC. Specifically.254 for 5% level of significance tabulated in Stoline and Ury (1979). we do the pair-wise SD comparisons by employing the DD test for all banks in these two groups.2794 and 2. (2008) to make 10 major partitions with 10 minor partitions within any two consecutive major partitions in each 2 Refer to Lean et al. k . Critical value is 3. Although FHC-banks have higher return than independent banks.12628 Afr. non-existence of any arbitrage opportunity between these two prospects and neither of these two prospects are preferred to one another. we follow Fong et al. In this situation. We note that in these hypotheses... a particular prospect stochastically dominates another prospect at first-order. Fj ( xi ) < G j ( xi ) for some xi . the following hypotheses are tested: H 0 : Fj ( xi ) = G j ( xi ) for all xi . 2. H A : Fj ( xi ) ≠ G j ( xi ) for some xi . 1989).α for some i. A non-satiation risk-averse investor is indifferent between FHC-banks and independent banks to maximize his expected utility. Manage.3017%. In addition. J.α for all i and − T j ( xi ) > M ∞ .. the independent banks have larger skewness and kurtosis in average than the FHC banks. In this situation.0213 versus 0. H A 2 : Fj ( xi ) ≥ G j ( xi ) for all xi . Tse and Zhang (2004) suggested that an appropriate choice of k for a reasonably large sample ranges from 6 to 15.nor independent banks experienced any negative average return even though the global financial crisis happened during the sample period.. we will not say hypothesis.. and k k if T j ( xi ) > M ∞ . However. Richmond (1982) argued that too many grids will violate the independence assumption required by the SMM distribution while Barrett and Donald (2003) noted that too few grids will miss information of the distributions between any two consecutive grids. accept H A .0117) also shows that investment in FHC-banks is better off.α for some i and − T j ( xi ) > M ∞ .α for i = 1. Daily mean return of FHC-banks is higher than the independent banks in average for about 70% (0. However. 1982) to account for joint test size. we replace the first variable (F) with FHCbank and the second variable (G) with independent bank in Equation 2. k k if T j ( xi ) < M ∞ .. accept H 0 . on average. comparison and to make the statistical inference based on the SMM distribution for k =10 and infinite degrees of freedom2. The SMM distribution with k and infinite degrees of freedom. This allows the examination of the consistency of both magnitudes and signs of the DD statistics between any two consecutive major partitions without violating the independent assumption. but not wealth (Jarrow. respectively). FHC-banks are superior to the independent banks with higher return and lower risk.

0136 0.1991 0.2068 0.4941 1.6165 2.0283 Std. Tainan Business Bank (now known as King's Town Bank). dev.0277 0.2794 0.5702 2.1191 0.1492 0.0302 0.0296 0.1554 2. SD tests results between independent and FHC banks in Taiwan.4410 2.0624 0.0057 0.0213 The independent banks. row F1 shows bank F1 dominates 3 independent bank banks and it is not dominated by any independent bank. Bank of Kaohsiung. #D means number of independent bank that is dominated by the particular FHC bank. F1 “D” I2 means bank F1 dominates bank I2 at second-order and third-order.0025 0.0069 0.9471 1. .7272 2.2292 0. For example.0815 0.2711 1.1053 2.0319 0.0682 0.0236 0.5959 1.0173 0.0117 0.3546 2.0330 1.0152 0.0683 0.0068 0.1151 0. F1 “N” I1 means there is no stochastic dominance between F1 and I1.2214 1.3017 Skewness 0.0380 0. Union Bank of Taiwa and EnTie Commercial Bank.0640 0.0317 0.1180 1.0518 0. some of them are from Table 1. F6 “T” I1 means bank F6 is dominated by bank I1 at second-order and third-order.0771 0.0198 0.3615 1. Bank F1 F2 F3 F4 F5 F6 F7 F8 F9 F10 F11 F12 F13 Total I1 N N N N N T N T T D N T* N I2 D D N D D N D N T D N N D I3 D* N N N N T D N T D N N N I4 N N T N N T N T T N T T N I5 D N N N D N D N T D N N N #D 3 1 0 1 2 0 3 0 0 4 0 0 1 15 #T 0 0 1 0 0 3 0 2 5 0 1 2 0 14 D means “dominates at second-order and third-order”.0826 2.7090 2.0337 0.0491 2. N means “no stochastic dominance” and * refers to first-order dominance.7462 Sharpe 0.6982 2.1834 0.4288 0.0297 0.0154 0.0466 0.0122 0.1076 0. Descriptive statistics for independent and FHC banks in Taiwan. Banks Independent I1 I2 I3 I4 I5 Average FHCF1 F2 F3 F4 F5 F6 F7 F8 F9 F10 F11 F12 F13 Average Mean 0.0299 0.9675 2.2486 0. Among FHCbanks.0224 1.0246 0.0147 0.1330 0.0854 0.1979 0.0752 0. Table 3.0269 0.2514 0.2884 1.9701 2. I1~I5 are Chang Hwa Bank.0943 2. and others are newly established. T means “is dominated at second-order and third-order”.0592 0.6265 2.7178 0.0974 0.0035 0.0154 0.1173 0.7427 1.2241 2.1298 2.7792 1. 2.2826 2.6337 3.4315 1.2865 2.1804 2. For example. #T means number of independent bank that dominates the particular FHC bank.Chang and Leann 12629 Table 2.0607 0.0361 0.2054 Kurtosis 1.0360 0.1640 0.2025 2.4583 2.0129 0.

after matching. b) PSM to collect samples of FHC-banks which share similar characterisic varaibles with independent banks. We can observe some domination for individual bank. However. In a situation where the FSD holds for a long time and all investors increase their expected wealth by switching their asset choice. Thus. Manage. stock market performance differences between two group may not be attribute to effect of joining FHC. and investors will increase their wealth and expected utilities if they shift from holding the dominated asset to the dominant one. Thus. Taiwan stock market does not price financial . the FSD should not last for a long period of time because market forces induce adjustments to a condition of no FSD if the market is rational and efficient. 2009). the changes owing to the experiment between treatment sample and control sample is referred to as experimental or treatment effect (purely joining-FHC effects). A non-satiation risk-averse investor is indifferent between FHC-banks and independent banks to maximize his expected utility. we have 5 FHC-banks and 5 independent banks. While our comparisons are based on FHC-banks and independent banks. Empirically evidence shows that there is dominance in stock returns of FHC-banks relative to independent banks. In general. both are intuitive methods to match samples with similar charactersitics.12630 Afr. There are two cases of FSD: F1 is FSD I3 while I1 is FSD F12. one might wonder if we could attribute the stock market performance difference to the effects of banks joining FHC on performance. the number of cases that FHC bank dominates independent bank (6 cases) are approximately equal to the number of cases that FHC bank is dominated by independent bank (8 cases). we try to match similar-in-characteristics FHC-banks with independent banks.versus independent banks is not a random process and may be endogenously determined. For simplicity. F1 and F7 also doing quite well in dominating three independent banks while F6 is dominated by three independent banks. In general. we claim that the market is neither efficient nor rational. Based on after-matching samples. In addtion. which provide an further motive for banks to diversify and policy implication for stockholder’s wealth of banks. Bus. (2008) claim that if FSD exists statistically. Another possibility for the existence of FSD to be held for a long period is that investors do not realize that such dominance exists. b) proposed propensity score matching (PSM). Because of bank’s characteristic variables such as scale. F5 is also doing quite well in dominating two independent banks while F8 is dominated by two independent banks. Then for each firm in the treatment sample. Many studies such as Jarrow (1986) and Falk and Levy (1989) claim that if FSD exists. F10 performs the best as it dominates four independent banks while F9 performs the worst because it is dominated by all the five independent banks. 1985a. and then Rosenbaum and Rubin (1983. Conclusion Taiwan’s financial consolidation reform in 2001 are based on the conventional wisdom which advocates that bank diversification reduce risks and enhence performance. on average. Why we do this is that because the classification of FHC. b) is that non-participants of experiment (firms without doing CSR) that have similar characteristics with participants (CSR firms) are called the controlled samples. J. Table 4. banks with better accounting performance in the past tend to join FHC. but investors can increase their expected wealth as well as their expected utility if they shift from holding the dominated asset to the dominant one. based on their stock return during the sample period. or banks with large scale tend to join FHC. Bank F5 F8 F9 F10 F11 Total I1 N T T D N I2 D N T D N I3 N N T D N I4 N T T N T I5 D N T D N #D 2 0 0 4 0 6 #T 0 2 5 0 1 8 Similar with Table 3. The PSM firstly estimate the probability of including in the experiment (propensity score) by all samples using characteristic variables as the explanatory variables. Wong et al. debt ratio and the ratio of revenue from non-traditional activities to total revenue. the DD test results are summarized in Table 4. In other word. b) developed matching theory. firms in the control samples are selected as matched samples according to the closeness of the estimated probability (Shen and Chang. characteristic variables are ASSET (natural log current-period total assets). Rubin (1973a. The basic concept of Rubin (1973a. For example. now. We employ Rosenbaum and Rubin’s (1983. nearly a decade after FHC Act was passed. If this possibility exists. recent financial tsunami shows that financail diversification lead to higher risks and lower performance. F10 performs the best as it dominates four independent banks while F9 performs the worst because it is dominated by all the five independent banks. arbitrage opportunities may not exist. we need an evaluations of the policy impacts of the change in legislation and regulatory environment of Taiwan’s banking industry. Thus. DEBTL (last-period debt ratio) and PROFITL (last-period after-tax profits levels). being a FHC-bank does not bring any obvious advantages on stock market performance in term of motivate a riskaverse investor’s preference to buy its stock. 1985a. SD tests results between independent and FHCBanks using after-matching samples. under certain conditions arbitrage opportunities also exist.

Levine R (2007). Bus. 10: 849-866. Duclos JY (2000).. Maasoumi E. Financ. equity ownership.. Donald SG (2003). Convergence of the south and non-south income distributions. The value of diversification during the conglomerate merger wave. Reserve Bank Minneapolis Q. Financ. Rev. Financ. Hayes K. J. 64: 1183-1193. (2004). Econometrica. Universal banking in the United States: what could we gain? what could we lose? Oxford University Press. Rev. Thakor A (1984). Whitmore GA (1970).. and product mix economies. A general method for constructing simultaneous confidence intervals. 1: 33-56. Financ.. Schenone C. Financial intermediary coalitions. 66: 437-462. Manage.. Financ. Math. Rothschild M. Financ. Financ. J. Hadar J. Econ. Gande A. Econ. Am. Prescott E (1986). 40: 373-401. Econ. Econ. 41: 915-921. 2: 225-243. Speculative trading and stock returns: a stochastic dominance analysis of the Chinese A-share market.. Springer Verlag. Mark. Rev. A robust test for stochastic dominance. The effect of banking relationships on the firm's IPO underpricing.. Simul. Am.. Berger A. Financ. Klecan L. Rao BL. Rev. Saunders A. 10: 1175-1202.. The effects of non-bank diversification on bank holding company risk. McFadden D (1989). Diversification of the banking firm. Boyd J. Manage. Ferrier G. Stochastic dominance: investment decision making under uncertainty. Revisiting calendar anomalies in Asian stock markets using a stochastic dominance approach. 76: 323-329. 36: 853-882.. Rev. Sarin A (1997). Assoc. J. Lean HH.. Stiglitz JE (1970). Information reliability and a theory of financial intermediation. Humphrey D (1993). Denis DJ. Kaur A. Econ. Tables of the studentised maximum modulus distribution and an application to multiple comparisons among means. Kluwer Academic Publishers. Russell WR (1969). 59: 25-34. Berger A. McFadden R.. 68: 1435-1464. Economic Theory. Financ. Wei S. New York. Rev. Stochastic dominance and expected utility: survey and analysis. Levy H (1989). Diversification’s effect on firm value. Working paper. Lean HH (2005). 84: 810-832. Stud. . Eur. 77: 455-460. Monet. An empirical study on the operational efficiency of Taiwan's banking industry: the effect of the Financial Holding Company Act. Rev. Wong WK. Manage. Stat. J. Testing for stochastic dominance. Templeton WK. Market reaction to quarterly earnings' announcements: a stochastic dominance based test of market efficiency. 38: 555-593. Rules for ordering uncertain prospects. In Fomby T. 20: 501-520. Value Added: Risk or Return? London: Financial Times/Prentice Hall.. Severiens JT (1992). The dominance of inefficiencies over scale and product mix economies in banking. Econ. Walter I (1997). Cerasi V. Am. 31: 229-249. Grosskopf S. Stein J (2002). Econ. Comput. Ofek E (1995). Simul. 79: 30-48. Hsu YP. Testing for second-order stochastic dominance of two distributions.Chang and Leann 12631 consolidation during our sample period. consequences. 113-132. Thistle PD (1992). 99: 689-721. Insiders and outsiders: the choice between informed and arm’s-length debt. J. Walter I (1994). Rajan R (1994). Stat. 51: 415-432. Fong WM. Strahan P (1999). Technometrica. J. J. corporate finance. J. Risk Manage. 59: 2903-2958. Is the Glass–Steagall Act justified? a study of the US experience with universal banking before 1933. Consistent testing for stochastic dominance under general sampling schemes. J. 8: 89-109. 59:393-414. Theory. A Monte Carlo investigation of some tests for stochastic dominance. Bus. Wong WK (2007). Financ. Anderson G (1996). Ury HA (1979). Boyd J. Comput. 712-727. Ramakrishnan R. Bank. 38: 211-232.. Rev. Mark. Seo T (eds). American Econ. Barrett GF. Is there a diversification discount in financial conglomerates. Statistical inference for stochastic dominance and for the measurement of poverty and inequality. J. 47: 1367-1400. Econ.. J. Levy H (1992). Monitoring and reputation: the choice between bank loans and directly placed debt. REFERENCES Acharya V. J.. Daltung S (2000). Zhang C (2003). Manage. J. Financ.. Should banks be diversified? evidence from individual bank loan portfolios. Whang YJ (2005). Demsetz R. J. 82: 262-272. Anderson G (2004). Lean HH.. Stud. pp. Bishop JA. Jarrow R (1986). Fong WM (2009). 476-514.). Graham SL (1988). Am. Econ. Quarterly J. Chang HC (2005). Agency problems. and implications for the future. Davidson R. J. Tse YK. 24: 251-280... Rev. Financ.. The relationship between arbitrage and first order stochastic dominance. 44: 1701-1726. Rajan R (1992).. Falk H. J. Econom. Size and power of some stochastic dominance tests: a monte carlo study for correlated and heteroskedastic distributions. Multinatl. Zhang XB (2008). Wong WK. a definition. Economies of diversification in the banking industry: a frontier approach. Future study needs to match samples for similar size or other characteristic variables (Rosenbaum and Rubin. 1985a. Rev. Pol. Richmond J (1982).. The consolidation of financial services industry: causes.. Monet.. The profitability and risk effects of allowing bank holding companies to merge with other financial firms: a simulation study.. Financ. J. Commercial banks in investment banking: conflicts of interest or certification role. 79: 1355-1412. Rose PS (1989).. Intern. 21: 87-93. Saunders A (2006). 35: 425-446. Toward an empirical analysis of polarization. 28: 117-148. Consistent tests for stochastic dominance. Diamond D (1984). Financ. 71: 71-104. Theory. Econ. b) to control for scale effect on performance and lengthening the data to examine the synergic effects of bank consolidation on performance is also needed. Stud. Econ. Stud. Econ. Financ. Inst.. Pulley L. The role of fixed costs and cost complementarities in determining scope economies and the costs of narrow banking proposals. scope. Rev.. International momentum strategies: a stochastic dominance approach. pp. Humphrey D (1987). The efficiency analysis of choices involving risk. Laeven L. Econ. DeYoung R. Hanweck G. and takeovers. Agency costs of free cash flow.. Humphrey D (1991). and government policy persuades banks to stretch their optimal scope and aggressively diversify themselves in order to improve in stockholder wealth of banks. 52:135-160. Singh H (1994). Sci. 193-198. Servaes H. 37: 39-65. Econom. The optimal size of a bank: costs and benefits of diversification. Levy H (1969). 31: 3-17. Econ. Competitive viability in banking: scale. 60: 457-459. Increasing risk I. Studies in the Economics of Uncertainty. J. Saunders A. 13: 443-463. J. Rev. Levy H (1998). J. Statistical and economic significance of stock return predictability: a mean-variance analysis.. Berger A... Roland KP (2001). Financial intermediation and delegated monitoring. Information production and capital allocation: decentralized versus hierarchical firms. Bank underwriting of debt securities: modern evidence. 74: 361-378. Rev. Rev. Nonparametric tests of stochastic dominance in income distributions. Third-degree stochastic dominance. Hanoch G. 51: 1201-1225. (1996). Financ.. Stoline MR. Jensen M (1986). Am. 17: 125-141. Econometrica.. 85: 331-367. Linton O. Kroszner R. New York.. 72: 735-765. Puri M. MIT and Cornerstone Research. Monetary Econ. Econometrica. and corporate diversification. 36: 335-346. McFadden D (1991).. Diamond D (1991). 122: 1-26.. Smyth R. Yaisawarng S (1993).. Bus.. Econ. Denis Dk. 57: 1891-1921. Fed. J. A risk-return framework for multiple product industries. Hasan I. Econ. J. 23:135-194. J. Multinational Financ. Sci. Puri M (1996). J. Money. Berger A. Emmanuel Acar (ed. Diversification in banking: is noninterest income the answer? J. Studies. J. Stiroh KJ (2004). Econ. Money Credit Bank. US. Formly JP. Zhang X (2004)..