The impact of off-balance-sheet activities on banks returns: An application of the ARCH-M to Canadian data

This paper revisits the impact of off-balance-sheet (OBS) activities on banks risk-return trade-off. Recent studies (e.g., Stiroh and Rumble, 2006) show that increasing OBS activities does not necessarily yield straightforward diversification benefits for banks. However, introducing a risk premium in the standard banks returns models, and resorting to an ARCH-M procedure, Canadian data suggest that banks risk-return trade-off displays a structural break around 1997. In the second subperiod of our sample (1997–2007), we find that the noninterest income generated by OBS activities no longer impacts banks returns negatively. While during the first period (1988–1996) the volatility variable is not significant in any returns equations, a risk premium eventually emerges, pricing the risk associated to OBS activities.