How does the stock market value bank diversification? Empirical evidence from Japanese banks

•We examine the effect of revenue diversification on bank performance and risk.•We measure bank performance and risk, using stock market data of Japanese banks.•We find a positive effect of banks' revenue diversification on bank values.•A shift toward fee income-generating business decreases all types of risk measures.•The effects of revenue diversification are affected by some characteristics of banks.

This paper empirically examines the effect of banks' revenue diversification across different activities on the stock-based return and risk measures using data on the Japanese banking sector. In our analyses, we use non-interest income share as a measure for revenue diversification. These analyses indicate that revenue diversification positively affects bank market value but provide no evidence that it reduce bank risks. By contrast, when non-interest income is divided into its constituent parts—fee income, trading income, and other non-interest income—we find that a shift towards fee income-generating business decreases all types of risks (systematic risk, idiosyncratic risk, and total risk). Furthermore, we find that revenue diversification affects bank value and risk differently depending on particular bank characteristics, such as organizational form and traditional banking business performance.