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Extracting Leading Indicators of Bank Fragility from Market Prices - Estonia Focus

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  • Yu-Fu Chen
  • Michael Funke
  • Kadri Männasoo

Abstract

Banking reform has proved to be one of the most problematic elements of economic transition in central and eastern Europe. Therefore the paper considers the development of the Estonian banking sector and derives individual banks´ fragility scores during transition. To this end we use option-based tools and equity prices to estimate distance-to-default measures of banks´ distress probabilities. Overall, the results suggest that market indicators are moderately useful for anticipating future financial distress and rating changes in transition economies. The implication for an effective supervisory framework is to use a plurality of risk scores when assessing bank vulnerability.

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File URL: http://www.dundee.ac.uk/media/dundeewebsite/economicstudies/documents/discussion/DDPE_185.pdf
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Bibliographic Info

Paper provided by Economic Studies, University of Dundee in its series Dundee Discussion Papers in Economics with number 185.

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Length: 25 pages
Date of creation: Dec 2005
Date of revision:
Handle: RePEc:dun:dpaper:185

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Keywords: Banking; Financial Stability; Bank Fragility; Options; Estonia;

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  1. 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.
  2. Demirguc-Kunt, Asli & Detragiache, Enrica, 2005. "Cross-country empirical studies of systemic bank distress : a survey," Policy Research Working Paper Series 3719, The World Bank.
  3. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-38, August.
  4. Reint Gropp & Vesala Jukka & Giuseppe Vulpes, 2004. "Market Indicators, Bank Fragility, and Indirect Market Discipline," Finance 0411015, EconWPA.
  5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  6. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  7. 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.
  8. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
  10. Bongini, Paola & Laeven, Luc & Majnoni, Giovanni, 2002. "How good is the market at assessing bank fragility? A horse race between different indicators," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1011-1028, May.
  11. Alain Bensoussan & Michel Crouhy & Dan Galai, 1994. "Stochastic equity volatility related to the leverage effect," Applied Mathematical Finance, Taylor & Francis Journals, vol. 1(1), pages 63-85.
  12. 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.
  13. 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.
  14. Jeffery W. Gunther & Mark E. Levonian & Robert R. Moore, 2001. "Can the stock market tell bank supervisors anything they don't already know?," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q II, pages 2-9.
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Cited by:
  1. Casu, Barbara & Clare, Andrew & Saleh, Nashwa, 2011. "Towards a new model for early warning signals for systemic financial fragility and near crises: an application to OECD countries," MPRA Paper 37043, University Library of Munich, Germany.
  2. Forges, Françoise & Koessler, Frédéric, 2008. "Long persuasion games," Journal of Economic Theory, Elsevier, vol. 143(1), pages 1-35, November.
  3. Eichler, Stefan & Karmann, Alexander & Maltritz, Dominik, 2010. "Deriving the term structure of banking crisis risk with a compound option approach: The case of Kazakhstan," Discussion Paper Series 2: Banking and Financial Studies 2010,01, Deutsche Bundesbank, Research Centre.
  4. Boris Blagov, 2013. "Financial crises and time- varying risk premia in a small open economy: a Markov-Switching DSGE model for Estonia," Bank of Estonia Working Papers wp2013-8, Bank of Estonia, revised 09 Dec 2013.

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