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Ambiguity and risk factors in bank stocks

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  • Luis García‐Feijóo
  • Ariel M. Viale

Abstract

The determinants of banks' cost of equity are not well understood. We depart from prior work assuming rational expectations and instead explore the impact of Knightian uncertainty or ambiguity on bank stocks. We test a large set of asset pricing models and find that investors' lack of confidence in both the drift and correlation structure driving bank stock returns affects banks' cost of capital. We also investigate the economic relation among ambiguity, market liquidity, and banks' capital shortfall, which reveals the transmission channels through which ambiguity may increase the probability of a systemic crisis. Our findings have implications for macroprudential policy.

Suggested Citation

  • Luis García‐Feijóo & Ariel M. Viale, 2023. "Ambiguity and risk factors in bank stocks," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 46(4), pages 993-1019, December.
    • Handle: RePEc:bla:jfnres:v:46:y:2023:i:4:p:993-1019
    DOI: 10.1111/jfir.12346
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