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Can the stock market tell bank supervisors anything they don't already know?

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  • Jeffery W. Gunther
  • Mark E. Levonian
  • Robert R. Moore
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    Abstract

    This article provides evidence consistent with recent policy proposals calling for a greater role for market forces in promoting a safe and sound financial system. The authors' empirical results indicate a measure of expected default probability distilled from equity prices helps predict the financial condition of individual banking organizations, as reflected in their supervisory ratings. Moreover, the stock market data have predictive power over and above the information in the quarterly financial statements available to supervisors between inspections. These findings suggest financial markets can provide useful information to supplement supervisory assessments, particularly between inspections, and point to the value of additional research to further clarify the information content of market prices and quantities.

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    File URL: http://www.dallasfed.org/assets/documents/research/efr/2001/efr0102a.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of Dallas in its journal Economic and Financial Policy Review.

    Volume (Year): (2001)
    Issue (Month): Q II ()
    Pages: 2-9

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    Handle: RePEc:fip:fedder:y:2001:i:qii:p:2-9

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    Keywords: Banks and banking ; Bank examination ; Bank supervision;

    References

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    1. Berger, Allen N & Davies, Sally M & Flannery, Mark J, 2000. "Comparing Market and Supervisory Assessments of Bank Performance: Who Knows What When?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 641-67, August.
    2. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. John Krainer & Jose A. Lopez, 2001. "Incorporating equity market information into supervisory monitoring models," Working Paper Series 2001-14, Federal Reserve Bank of San Francisco.
    4. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
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    Cited by:
    1. Yu-Fu Chen & Michael Funke & Kadri Männasoo, 2005. "Extracting Leading Indicators of Bank Fragility from Market Prices - Estonia Focus," Dundee Discussion Papers in Economics 185, Economic Studies, University of Dundee.
    2. Francesco Cannata & Mario Quagliariello, . "Market and Supervisory Information: Some Evidence from Italian Banks," Discussion Papers 04/04, Department of Economics, University of York.
    3. Douglas D. Evanoff & Larry D. Wall, 2003. "Subordinated debt and prompt corrective regulatory action," Working Paper Series WP-03-03, Federal Reserve Bank of Chicago.
    4. John Krainer & Jose A. Lopez, 2003. "How might financial market information be used for supervisory purposes?," Economic Review, Federal Reserve Bank of San Francisco, pages 29-45.
    5. R. Alton Gilbert & Andrew P. Meyer & Mark D. Vaughan, 2006. "Can feedback from the jumbo CD market improve bank surveillance?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 135-175.
    6. Maltritz, Dominik, 2010. "A compound option approach to model the interrelation between banking crises and country defaults: The case of Hungary 2008," Journal of Banking & Finance, Elsevier, vol. 34(12), pages 3025-3036, December.
    7. Arnaud Jobert & Janet Kong & Jorge A. Chan-Lau, 2004. "An Option-Based Approach to Bank Vulnerabilities in Emerging Markets," IMF Working Papers 04/33, International Monetary Fund.
    8. Martin CIHAK, 2007. "Systemic Loss: A Measure of Financial Stability (in English)," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(1-2), pages 5-26, March.
    9. Eichler, Stefan & Karmann, Alexander & Maltritz, Dominik, 2011. "The term structure of banking crisis risk in the United States: A market data based compound option approach," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 876-885, April.
    10. Maltritz, Dominik & Eichler, Stefan, 2010. "Currency crisis prediction using ADR market data: An options-based approach," International Journal of Forecasting, Elsevier, vol. 26(4), pages 858-884, October.
    11. Gaul, Lewis & Palvia, Ajay, 2013. "Are regulatory management evaluations informative about bank accounting returns and risk?," Journal of Economics and Business, Elsevier, vol. 66(C), pages 1-21.

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