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Optimal Bank Capital with Costly Recapitalization

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Author Info

  • Samu Peura

    (Sampo Bank)

  • Jussi Keppo

    (University of Michigan)

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    Abstract

    We study optimal bank capital choice as a dynamic trade-off between the opportunity cost of equity, the loss of franchise value following a regulatory minimum capital violation, and the cost of recapitalization. We introduce a recapitalization delay that results in a strictly positive probability of capital adequacy violation. We calibrate the model to bank accounting return data and evaluate the model's ability to explain observed bank capital ratios. Differences in return volatility explain a significant fraction of the cross-sectional variation in bank capital ratios. Differences in the level of capital market imperfections across banks constitute a secondary explanation.

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    Bibliographic Info

    Article provided by University of Chicago Press in its journal Journal of Business.

    Volume (Year): 79 (2006)
    Issue (Month): 4 (July)
    Pages: 2163-2202

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    Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:4:p:2163-2202

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    Web page: http://www.journals.uchicago.edu/JB/

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