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Capital ratios and the cross-section of bank stock returns: Evidence from Japan

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  • Chen, Sichong

Abstract

We propose a market-valued capital ratio as an indicator to gauge the riskiness of banks. In particular, we examine the cross-sectional relation between the market-valued capital ratio and stock returns of listed Japanese banks. It is found that banks with lower market-valued capital ratios have had higher returns on average than banks with higher market-valued capital ratios. However, we show that this negative relation between market-valued capital ratio and average stock returns could essentially be attributed to differences in exposure to risk factors. The market-valued capital ratio appears to proxy for sensitivity to common risk factors in bank stock returns. We also relate the cross-sectional variation in market-valued capital ratios to systematic patterns in relative profitability by showing that low market-valued capital ratio signals persistently poor profitability. Finally, we provide evidence to show that the market-valued capital ratio can indeed serve as a strong predictive indicator for bank's share performance during the financial crisis in the late 1990s, even after controlling for a variety of other traditional risk measures.

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  • Chen, Sichong, 2011. "Capital ratios and the cross-section of bank stock returns: Evidence from Japan," Journal of Asian Economics, Elsevier, vol. 22(2), pages 99-114, April.
    • Handle: RePEc:eee:asieco:v:22:y:2011:i:2:p:99-114
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    1. Sichong Chen, 2010. "What Drives The Time‐Series And Cross‐Sectional Variations In Bank Capital Ratios? Evidence From Japan," Pacific Economic Review, Wiley Blackwell, vol. 15(5), pages 743-755, December.
    2. Chowdhury, Biplob & Jeyasreedharan, Nagaratnam, 2019. "An empirical examination of the jump and diffusion aspects of asset pricing: Japanese evidence," Working Papers 2019-02, University of Tasmania, Tasmanian School of Business and Economics.
    3. Huang, Alan Guoming & Sun, Kevin Jialin, 2019. "Equity financing restrictions and the asset growth effect: International vs. Asian evidence," Pacific-Basin Finance Journal, Elsevier, vol. 57(C).

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