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Effect Of Fed Policy Actions On The Default Likelihood Of Commercial Banks

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  • Aigbe Akhigbe
  • Jeff Madura
  • Anna D. Martin

Abstract

Using a measure of default likelihood based on an option pricing method, we provide evidence that Fed policy actions affect the financial distress of commercial banks. When the Fed increases (decreases) interest rates, the measure of default likelihood increases (decreases). We show that when the Fed uses a tight money policy, the increase in default likelihood is more pronounced for banks that have less capital, have greater financial leverage, are smaller, have fewer growth opportunities, and have lower asset quality. Additionally, the effects on bank default likelihood are more pronounced when the Fed's policy signals less concern about economic growth, as indicated by its bias toward further tightening, and when there is a market expectation of higher short-term market rates in the future. 2007 The Southern Finance Association and the Southwestern Finance Association.

Suggested Citation

  • Aigbe Akhigbe & Jeff Madura & Anna D. Martin, 2007. "Effect Of Fed Policy Actions On The Default Likelihood Of Commercial Banks," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 30(1), pages 147-162.
  • Handle: RePEc:bla:jfnres:v:30:y:2007:i:1:p:147-162
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    Cited by:

    1. Hagendorff, Jens & Vallascas, Francesco, 2011. "CEO pay incentives and risk-taking: Evidence from bank acquisitions," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 1078-1095, September.
    2. Fu, Xiaoqing (Maggie) & Lin, Yongjia (Rebecca) & Molyneux, Philip, 2014. "Bank competition and financial stability in Asia Pacific," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 64-77.
    3. Vallascas, Francesco & Keasey, Kevin, 2012. "Bank resilience to systemic shocks and the stability of banking systems: Small is beautiful," Journal of International Money and Finance, Elsevier, vol. 31(6), pages 1745-1776.
    4. repec:eee:intfin:v:53:y:2018:i:c:p:200-214 is not listed on IDEAS

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