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Market Valuation and Risk Assessment of Canadian Banks

  • Liu, Ying
  • Papakirykos, Eli
  • Yuan, Mingwei

This paper applies the asset valuation model developed by Rabinovitch (1989) to the six largest Canadian banks. The model is an extension of the Merton (1977a) option-pricing model with the incorporation of stochastic interest rates. We then introduce a measure of distance-to default, Z-score. Our results indicate that the market value of bank assets is almost always below its book value and that Canadian banks have a very low insolvency risk over time, except for 1982 and 1983. We also find that both the market valuation of the bank assets and the z-score of these Canadian banks demonstrate similar regime switches in the late 1990s, which may be related to regulatory changes during the 1990s.

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Article provided by Review of Applied Economics in its journal Review of Applied Economics.

Volume (Year): 2 (2006)
Issue (Month): 1 ()

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Handle: RePEc:ags:reapec:50281
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  1. 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.
  2. 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.
  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, 2002. "Equity and bond market signals as leading indicators of bank fragility," Working Paper Series 0150, European Central Bank.
  5. Christian Calmès, 2004. "Financial Market Imperfection, Overinvestment,and Speculative Precaution," Staff Working Papers 04-27, Bank of Canada.
  6. George Lermer, 1980. "The Performance of Canadian Banking," Canadian Journal of Economics, Canadian Economics Association, vol. 13(4), pages 578-93, November.
  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. 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.
  9. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  10. 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.
  11. 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.
  12. Luc Laeven, 2002. "Bank Risk and Deposit Insurance," World Bank Economic Review, World Bank Group, vol. 16(1), pages 109-137, June.
  13. 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.
  14. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July.
  15. 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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