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Market Valuation and Risk Assessment of Canadian Banks

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Author Info

  • Ying Liu
  • Eli Papakirykos
  • Mingwei Yuan

Abstract

The authors apply the asset-valuation model developed by Rabinovitch (1989) to six publicly traded Canadian banks over the period 1982–2002. The model is an extension of the Merton (1977a) option-pricing model with the incorporation of stochastic interest rates. The authors introduce the Z-score, a measure of distance-to-default, which can be a useful tool for regulators in assessing the risk of bank failures. The Z-scores, overall, suggest that Canadian banks are far from the point of default. The authors also find that both the market valuation of the bank assets and the Z-score of the Canadian banks demonstrate similar regime shifts in the late 1990s, which may be related to regulatory changes during the 1990s.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 04-34.

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Length: 26 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:bca:bocawp:04-34

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Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/

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Keywords: Financial institutions;

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References

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  1. Yacine Ait-Sahalia, 1995. "Testing Continuous-Time Models of the Spot Interest Rate," NBER Working Papers 5346, National Bureau of Economic Research, Inc.
  2. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  3. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
  4. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
  5. Luc Laeven, 2002. "Bank Risk and Deposit Insurance," World Bank Economic Review, World Bank Group, vol. 16(1), pages 109-137, June.
  6. George Lermer, 1980. "The Performance of Canadian Banking," Canadian Journal of Economics, Canadian Economics Association, vol. 13(4), pages 578-93, November.
  7. Johnson, Herb & Shanno, David, 1987. "Option Pricing when the Variance Is Changing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 143-151, June.
  8. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
  9. Ronald Giammarino & Eduardo Schwartz & Josef Zechner, 1989. "Market Valuation of Bank Assets and Deposit Insurance in Canada," Canadian Journal of Economics, Canadian Economics Association, vol. 22(1), pages 109-27, February.
  10. Jin-Chuan, Duan & Moreau, Arthur F. & Sealey, C. W., 1995. "Deposit insurance and bank interest rate risk: Pricing and regulatory implications," Journal of Banking & Finance, Elsevier, vol. 19(6), pages 1091-1108, September.
  11. Ronn, Ehud I & Verma, Avinash K, 1986. " Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-95, September.
  12. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  13. Rabinovitch, Ramon, 1989. "Pricing Stock and Bond Options when the Default-Free Rate is Stochastic," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(04), pages 447-457, December.
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Citations

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Cited by:
  1. Greg Caldwell, 2005. "Subordinated Debt and Market Discipline in Canada," Working Papers 05-40, Bank of Canada.
  2. Amadou N. R. Sy & Jorge A. Chan-Lau, 2006. "Distance-to-Default in Banking: A Bridge Too Far?," IMF Working Papers 06/215, International Monetary Fund.
  3. Obaid Saif H. Al Zaabi, 2011. "Potential for the application of emerging market Z-score in UAE Islamic banks," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing, vol. 4(2), pages 158-173, June.

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