Mixing and Matching: Prospective Financial Sector Mergers and Market Valuation

Which types of mergers are likely to be most productive for banks and other financial firms in the United States after the Gramm-Leach-Bliley Act? From a management perspective, mixing disparate firms may be difficult, but may offer significant gains from diversification. The opposite applies to matching similar firms. This paper considers life insurance, property and casualty insurance, securities, and commercial firms as potential matches for banks. It examines two types of evidence extracted from stock price data. First, option-pricing theory is used to compute a direct measure of diversification gains from potential consolidation. These results identify potential gains in virtually all combinations involving banking, life insurance, and property and casualty insurance. Second, to understand the consolidation results better, arbitrage-pricing theory is used to identify the “building blocks” of the industries, which are then compared across sectors. There is evidence of substantial overlap in the basic factors for the banking and insurance industries. However, diversification potential between banks and insurance companies still exists because of differences in the way the basic factors are combined and because the insurance sectors are themselves well-diversified.