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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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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. 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.
  2. 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.
  3. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  4. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
  5. 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.
  6. 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.
  7. 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.
  8. George Lermer, 1980. "The Performance of Canadian Banking," Canadian Journal of Economics, Canadian Economics Association, vol. 13(4), pages 578-93, November.
  9. 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.
  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. Luc Laeven, 2002. "Bank Risk and Deposit Insurance," World Bank Economic Review, World Bank Group, vol. 16(1), pages 109-137, June.
  12. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
  13. 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.
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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," 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.
  4. Sinha, Pankaj & Sharma, Sakshi & Sondhi, Kriti, 2013. "Market Valuation and Risk Assessment of Indian Banks using Black -Scholes -Merton Model," MPRA Paper 47442, University Library of Munich, Germany.

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