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Measuring and Stress-Testing Market-Implied Bank Capital

Author

Listed:
  • Martin Indergand

    (Swiss National Bank - Financial Stability)

  • Eric Jondeau

    (University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute; Swiss Finance Institute)

  • Andreas Fuster

    (Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR))

Abstract

We propose a methodology for measuring the market-implied capital of banks by subtracting from the market value of equity (market capitalization) a credit-spread-based correction for the value of shareholders' default option. We show that without such a correction, the estimated impact of a severe market downturn is systematically distorted, underestimating the risk of banks with low market capitalization. We argue that this adjusted measure of capital is the relevant market-implied capital measure for policymakers. We propose an econometric model for the combined simulation of equity prices and CDS spreads, which allows us to introduce this correction in the SRISK framework for measuring systemic risk.

Suggested Citation

  • Martin Indergand & Eric Jondeau & Andreas Fuster, 2022. "Measuring and Stress-Testing Market-Implied Bank Capital," Swiss Finance Institute Research Paper Series 22-11, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2211
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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