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Equity market information, bank holding company risk, and market discipline

Author

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  • Curry, Timothy J.
  • Fissel, Gary S.
  • Hanweck, Gerald A.

Abstract

For market discipline to be effective, market factors such as changes in firm equity and debt values and returns, must influence firm decision making. In banking, this can occur directly via bank management or indirectly though supervisory examinations and oversight influencing bank management. In this study, we investigate whether equity market variables can provide timely information and add value to accounting models that predict changes in bank holding company (BOPEC) risk ratings over the 1988-2000 period. Using a variety of equity market indicators, the findings suggest that one-quarter lagged market data adds forecast value to lagged financial statement data and prior supervisory information in the logistic regressions. Furthermore, using extensive out-of-sample testing for the years 2001-2003, we find: (1) that multiple models estimated over different phases of the business and banking cycles are superior to a single model for forecasting BOPEC rating changes; (2) that equity data adds economically significant power in forecasting BOPEC rating upgrades and performs well for identifying no changes; (3) that for downgrades, the accounting model forecasts the best; (4) that modeling the three possible risk ratings categories simultaneously (downgrade, no change and upgrade) minimizes both Type I and Type II classification errors; and (5) that using multiple models to forecast risk ratings enhances the overall percentage of correct classifications.

Suggested Citation

  • Curry, Timothy J. & Fissel, Gary S. & Hanweck, Gerald A., 2008. "Equity market information, bank holding company risk, and market discipline," Journal of Banking & Finance, Elsevier, vol. 32(5), pages 807-819, May.
  • Handle: RePEc:eee:jbfina:v:32:y:2008:i:5:p:807-819
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    References listed on IDEAS

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    1. Berger, Allen N & Davies, Sally M & Flannery, Mark J, 2000. "Comparing Market and Supervisory Assessments of Bank Performance: Who Knows What When?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 641-667, August.
    2. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
    3. Francesco Cannata & Mario Quagliariello, 2005. "The Value of Market Information in Banking Supervision: Evidence from Italy," Journal of Financial Services Research, Springer;Western Finance Association, vol. 27(2), pages 139-162, April.
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    5. Krainer, John & Lopez, Jose A, 2004. "Incorporating Equity Market Information into Supervisory Monitoring Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 1043-1067, December.
    6. Mark Flannery, 2001. "The Faces of “Market Discipline”," Journal of Financial Services Research, Springer;Western Finance Association, vol. 20(2), pages 107-119, October.
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    Cited by:

    1. Gaul, Lewis & Palvia, Ajay, 2013. "Are regulatory management evaluations informative about bank accounting returns and risk?," Journal of Economics and Business, Elsevier, vol. 66(C), pages 1-21.
    2. Liao, Hsien-Hsing & Chen, Tsung-Kang & Lu, Chia-Wu, 2009. "Bank credit risk and structural credit models: Agency and information asymmetry perspectives," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1520-1530, August.
    3. Baele, Lieven & De Bruyckere, Valerie & De Jonghe, Olivier & Vander Vennet, Rudi, 2014. "Do stock markets discipline US Bank Holding Companies: Just monitoring, or also influencing?," The North American Journal of Economics and Finance, Elsevier, vol. 29(C), pages 124-145.
    4. repec:hal:journl:hal-00785449 is not listed on IDEAS
    5. Francesco Cannata & Mario Quagliariello, "undated". "Market and Supervisory Information: Some Evidence from Italian Banks," Discussion Papers 04/04, Department of Economics, University of York.
    6. Harashima, Taiji, 2011. "A Mechanism of Cyclical Volatility in the Vacancy-Unemployment Ratio: What Is the Source of Rigidity?," MPRA Paper 32476, University Library of Munich, Germany.
    7. Akhigbe, Aigbe & Madura, Jeff & Marciniak, Marek, 2012. "Bank capital and exposure to the financial crisis," Journal of Economics and Business, Elsevier, vol. 64(5), pages 377-392.
    8. Olivier de Bandt & Jean-Cyprien Héam & Claire Labonne & Santiago Tavolaro, 2015. "La mesure du risque systémique après la crise financière," Revue économique, Presses de Sciences-Po, vol. 66(3), pages 481-500.
    9. Davide Avino & Thomas Conlon & John Cotter, 2016. "Credit Default Swaps as Indicators of Bank Financial Distress," Working Papers 201601, Geary Institute, University College Dublin.
    10. O. de Bandt & J.-C. Héam & C. Labonne & S. Tavolaro, 2013. "Measuring Systemic Risk in a Post-Crisis World," Débats économiques et financiers 6, Banque de France.
    11. Bennett, Rosalind L. & Hwa, Vivian & Kwast, Myron L., 2015. "Market discipline by bank creditors during the 2008–2010 crisis," Journal of Financial Stability, Elsevier, vol. 20(C), pages 51-69.
    12. Calluzzo, Paul & Dong, Gang Nathan, 2015. "Has the financial system become safer after the crisis? The changing nature of financial institution risk," Journal of Banking & Finance, Elsevier, vol. 53(C), pages 233-248.
    13. Distinguin, Isabelle & Kouassi, Tchudjane & Tarazi, Amine, 2013. "Interbank deposits and market discipline: Evidence from Central and Eastern Europe," Journal of Comparative Economics, Elsevier, vol. 41(2), pages 544-560.
    14. Chan, Chia-Ying & Lo, Huai-Chun & Su, Yi-Ru, 2014. "Distribution of stock ratings and analyst recommendation revision," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 273-286.
    15. Thomas Conlon & John Cotter, 2015. "Eurozone bank resolution and Bail-In - Intervention, triggers and writedowns," Working Papers 201501, Geary Institute, University College Dublin.
    16. Harashima, Taiji, 2009. "Depression as a Nash Equilibrium Consisting of Strategies of Choosing a Pareto Inefficient Transition Path," MPRA Paper 18953, University Library of Munich, Germany.
    17. Selçuk Caner & Süheyla Özyıldırım & A. Ungan, 2012. "How Sensitive Are Bank Managers to Shareholder Value?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 42(3), pages 187-205, December.

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