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Equity and bond market signals as leading indicators of bank fragility

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Author Info
Giuseppe Vulpes () (UniCredit, Via Cerva 24, Milan ,MI 20122, Italy.)
Reint Gropp () (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
Jukka M. Vesala () (Bank of Finland - Finnish Financial Supervision Authority (FIN-FSA), P.O. Box 160, FIN-00101 Helsinki, Finland.)

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Abstract

We analyse EU banks' equity market-based distances-to-default and subordinated bond spreads in the secondary market in relation to their capability of signalling a material weakening in banks' financial condition. Both indicators are demonstrated to be complete indicators of bank fragility, reflecting relevant information of default risk; and also to be aligned with the supervisors' conservative perspective. We use two different econometric models: a logit-model, estimated for a number of different time-leads, and a Cox proportional hazard model. We find support in favour of using both the distance-to-default and spread as leading indicators of bank fragility, regardless of our econometric specification. However, while we find robust predictive performance of the distance-to-default between 6 to 18 months in advance, its predictive properties are quite poor closer to the "default" events. In contrast, all banks' subordinated debt spreads seem to have signal value, but close to the "default" events only. Otherwise, they appear to be significantly diluted by the expectation of public bailout, which is not the case with the equity market-based distances-to-default. JEL Classification: G21; G12.

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Paper provided by European Central Bank in its series Working Paper Series with number 150.

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Length: 59 pages
Date of creation: Jun 2002
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Handle: RePEc:ecb:ecbwps:20020150

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Keywords: Banking bank fragility market indicators.

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
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