Valuing the Treasury's Capital Assistance Program
The Capital Assistance Program (CAP) was created by the U.S. government in February 2009 to provide backup capital to large financial institutions unable to raise sufficient capital from private investors. Under the terms of the CAP, a participating bank receives contingent capital by issuing preferred shares to the Treasury combined with embedded options for both parties: The bank gets the option to redeem the shares or convert them to common equity, with conversion mandatory after seven years; the Treasury earns dividends on the preferred shares and gets warrants on the bank's common equity. We develop a contingent claims framework in which to estimate market values of these CAP securities. The interaction between the competing options held by the buyer and issuer of these securities creates a game between the two parties, and our approach captures this strategic element of the joint valuation problem and clarifies the incentives it creates. We apply our method to the 18 publicly held bank holding companies that participated in the Supervisory Capital Assessment Program (the stress test) launched together with the CAP. On average, we estimate that compared to a market transaction, the CAP securities carry a net value of approximately 30% of the capital invested for a bank participating to the maximum extent allowed under the terms of the program. We also find that the net value varies widely across banks. We compare our estimates with abnormal stock price returns for the stress test banks at the time the terms of the CAP were announced; we find correlations between 0.78 and 0.85, depending on the precise choice of period and set of banks included. These results suggest that our valuation aligns with shareholder perception of the value of the program, prompting questions about industry reactions and the overall impact of the program. This paper was accepted by Wei Xiong, finance.
Volume (Year): 57 (2011)
Issue (Month): 7 (July)
|Contact details of provider:|| Postal: 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA|
Web page: http://www.informs.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Sanjiv R. Das & Rangarajan K. Sundaram, 2007. "An Integrated Model for Hybrid Securities," Management Science, INFORMS, vol. 53(9), pages 1439-1451, September.
- Kashyap, Anil K. & Rajan, Raghuram G. & Stein, Jeremy C., 2008. "Rethinking capital regulation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 431-471.
- Jean-Charles Rochet & Xavier Vives, 2004.
"Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?,"
Journal of the European Economic Association,
MIT Press, vol. 2(6), pages 1116-1147, December.
- Rochet, Jean-Charles & Vives, Xavier, 2002. "Coordination failures and the lender of last resort : was Bagehot right after all?," HWWA Discussion Papers 184, Hamburg Institute of International Economics (HWWA).
- Jean-Charles Rochet & Xavier Vives, 2002. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," FMG Discussion Papers dp408, Financial Markets Group.
- Rochet, Jean-Charles & Vives, Xavier, 2004. "Coordination Failures and the Lender of Last Resort : Was Bagehot Right After All?," IDEI Working Papers 294, Institut d'Économie Industrielle (IDEI), Toulouse.
- Rochet, Jean-Charles & Vives, Xavier, 2002. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," CEPR Discussion Papers 3233, C.E.P.R. Discussion Papers.
- Jean-Charles Rochet & Xavier Vives, 2002. "Coordination failures and the lender of last resort: was Bagehot right after all?," LSE Research Online Documents on Economics 24928, London School of Economics and Political Science, LSE Library.
- Lucas, Deborah & McDonald, Robert L., 2006. "An options-based approach to evaluating the risk of Fannie Mae and Freddie Mac," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 155-176, January.
- Augustin Landier & Kenichi Ueda, 2009. "The Economics of Bank Restructuring; Understanding the Options," IMF Staff Position Notes 2009/12, International Monetary Fund.
- Holmstrom, B & Tirole, J, 1996.
"Private and Public Supply of Liquidity,"
96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
- Patrick Jaillet & Ehud I. Ronn & Stathis Tompaidis, 2004. "Valuation of Commodity-Based Swing Options," Management Science, INFORMS, vol. 50(7), pages 909-921, July.
- Ricardo J. Caballero & Arvind Krishnamurthy, 2008.
"Collective Risk Management in a Flight to Quality Episode,"
Journal of Finance,
American Finance Association, vol. 63(5), pages 2195-2230, October.
- Ricardo J. Caballero & Arvind Krishnamurthy, 2007. "Collective Risk Management in a Flight to Quality Episode," NBER Working Papers 12896, National Bureau of Economic Research, Inc.
- Peter Carr & Vadim Linetsky, 2006. "A jump to default extended CEV model: an application of Bessel processes," Finance and Stochastics, Springer, vol. 10(3), pages 303-330, September.
When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:57:y:2011:i:7:p:1195-1211. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.