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Book-to-market equity and asset correlations—An international study

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  • Ho, Kung-Cheng
  • Lee, Shih-Cheng
  • Chen, Jiun-Lin

Abstract

In this paper, we examine the use of book-to-market equity (BE/ME) as a determinant of asset correlations in the Basel Accord on regulatory capital requirements. Utilizing an international sample from 38 countries during 1989–2017, we discover that asset correlations, controlling for firm size and default probability, are negatively associated with BE/ME. We further decompose BE/ME according to Daniel and Titman (2006) and Penman et al. (2007) to explore why BE/ME can capture variations in asset correlations. The former method demonstrates that obligors with higher assets-in-place (higher BE/ME) exhibit lower asset correlations, and the latter approach reveals that obligors with higher operating risk have lower asset correlations. These findings suggest that BE/ME is potentially a crucial factor in improving estimates of asset correlations and reducing bank regulatory capital arbitrage.

Suggested Citation

  • Ho, Kung-Cheng & Lee, Shih-Cheng & Chen, Jiun-Lin, 2022. "Book-to-market equity and asset correlations—An international study," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 258-274.
    • Handle: RePEc:eee:reveco:v:79:y:2022:i:c:p:258-274
    DOI: 10.1016/j.iref.2022.02.014
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    More about this item

    Keywords

    Asset correlation; Basel Accord; Book-to-market equity; Default probability; Operating risk;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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