Do banks diversify portfolio risk? a test of the risk-cost hypothesis

Shin'ichi Hirota*, Yoshiro Tsutsui

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

3 Citations (Scopus)


proposes the risk-cost hypothesis that banks decide the number of loans by considering the costs arising from diversifiable portfolio risk. Thus, the banks do not minimize operation costs, but total costs including risk costs. This paper examines empirically whether the risk-cost hypothesis is valid, using financial panel data from Japanese banks from 1981 to 1994. Estimating the first-order condition of total cost minimization together with an operation cost function, we find that the hypothesis is supported. Dividing the sample into different types of banks, it is found that the hypothesis is valid for city and regional banks, but not for second regional banks.

Original languageEnglish
Pages (from-to)29-39
Number of pages11
JournalJapan and The World Economy
Issue number1
Publication statusPublished - 1999 Jan 1


  • Diversification
  • Economies of scale
  • G11
  • G21
  • Japanese banks
  • Loan size
  • Risk cost

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics
  • Political Science and International Relations


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