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Bank Risk - Return Efficiency and Bond Spread: Is There Evidence of Market Discipline in Europe

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  • Cecile Casteuble

    ()
    (LAPE - Laboratoire d'Analyse et de Prospective Economique - Université de Limoges : EA1088 - Institut Sciences de l'Homme et de la Société)

  • Emmanuelle Nys

    ()
    (LAPE - Laboratoire d'Analyse et de Prospective Economique - Université de Limoges : EA1088 - Institut Sciences de l'Homme et de la Société)

  • Philippe Rous

    ()
    (LAPE - Laboratoire d'Analyse et de Prospective Economique - Université de Limoges : EA1088 - Institut Sciences de l'Homme et de la Société)

Abstract

The aim of this paper is to empirically investigate the relationship between bank risk-return efficiency and bond spread priced in the primary market. Our study is based on a sample of European listed banks for the period 1996-2011. Applying a parametric frontier based on the Battese and Coelli (1993) model, we can compute risk-return efficiency score for each bank at each date. Compared to previous studies, we investigate the effectiveness of market discipline taking into account not only risk and return independently, but also the level of profitability for a given level of risk on the pricing of bond spread. We find that, over the complete sample period, bondholders require a higher spread from more inefficient banks. A closer analysis actually shows that market discipline is not effective during sound economic period, but market investors comes to discipline banks during distressed economic period by pricing lower spread to more efficient banks.

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Paper provided by HAL in its series Working Papers with number hal-00916717.

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Date of creation: 2013
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Handle: RePEc:hal:wpaper:hal-00916717

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  1. Olivier De Jonghe & Mustafa Disli & Koen Schoors, 2012. "Corporate Governance, Opaque Bank Activities, and Risk/Return Efficiency: Pre- and Post-Crisis Evidence from Turkey," Journal of Financial Services Research, Springer, vol. 41(1), pages 51-80, April.
  2. Donald Morgan & Kevin Stiroh, 2001. "Market Discipline of Banks: The Asset Test," Journal of Financial Services Research, Springer, vol. 20(2), pages 195-208, October.
  3. Julapa Jagtiani & George Kaufman & Catharine Lemieux, 2002. "The Effect of Credit Risk on Bank and Bank Holding Company Bond Yields: Evidence from the Post-FDICIA Period," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 25(4), pages 559-575.
  4. DeYoung, Robert E. & Hughes, Joseph P. & Moon, Choon-Geol, 2001. "Efficient risk-taking and regulatory covenant enforcement in a deregulated banking industry," Journal of Economics and Business, Elsevier, vol. 53(2-3), pages 255-282.
  5. Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September.
  6. Edwin J. Elton, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, 02.
  7. Donald P. Morgan & Kevin J. Stiroh, 1999. "Bond market discipline of banks: is the market tough enough?," Staff Reports 95, Federal Reserve Bank of New York.
  8. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt and bank capital reform," Working Paper Series, Federal Reserve Bank of Chicago WP-00-7, Federal Reserve Bank of Chicago.
  9. Flannery, Mark J & Sorescu, Sorin M, 1996. " Evidence of Bank Market Discipline in Subordinated Debenture Yields: 1983-1991," Journal of Finance, American Finance Association, vol. 51(4), pages 1347-77, September.
  10. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  11. Evanoff, Douglas D. & Jagtiani, Julapa A. & Nakata, Taisuke, 2011. "Enhancing market discipline in banking: The role of subordinated debt in financial regulatory reform," Journal of Economics and Business, Elsevier, vol. 63(1), pages 1-22.
  12. Andrea Sironi, 2000. "Testing for market discipline in the European banking industry: evidence from subordinated debt issues," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2000-40, Board of Governors of the Federal Reserve System (U.S.).
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