A Methodology for Analyzing the Effects of Geographic Diversification for Financial Institutions

Document Type

Article

Publication Date

1-2003

Publication Title

American Business Review

Abstract

This paper develops a methodology to examine and measure the potential benefits of risk reduction for financial institutions wishing to grow primarily through a strategy of geographic expansion. This paper focuses on measuring the benefits obtained from a broader expansion strategy that considers the eight regions of the US, as classified by the Bureau of Economic Analysis (BEA). The effect of regional diversification is measured using the annual return on equity (ROE) of federally insured commercial banks from 1969 to 1999. This paper provides a blueprint for a financial institution wishing to implement a strategic plan for geographic expansion. It takes the approach that a financial institution is seeking to grow by expanding into new regions and wants to build a company that minimizes risk while maintaining or increasing its ROE. Using portfolio theory, the optimal percentage of capital that the financial institution should invest in each new region is determined.

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Copyright University of New Haven Jan 2003

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