Cross-sector diversification in financial conglomerates: simulations with a fair-value assets and liabilities model

Abstract

Risk diversification is one of the many reasons for cross-sector mergers of financialinstitutes. This paper presents a fair-value type asset and liability model in order to identify diversification effects for financial conglomerates (PCs) under various shocks. My analysis for the Netherlands reveals that diversification effects on PCs of especially interest rate shocks are very strong. In principle, substantial diversificationeffects argue for lower capital requirements for PCs. However, there are other non-negligible risks run by PCs to consider, namely contagion risk, regulatory arbitrage andcross-sector and TBTF moral hazard risks, which have not yet been quantified.

Keywords

• merger