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Crisis-Related Shifts in the Market Valuation of Banking Activities

  • Charles W. Calomiris
  • Doron Nissim

We examine changes in the market valuation of banking activities over the last decade, focusing on the effects of the financial crisis. Our valuation model recognizes that banks create value through the types of assets and liabilities that they create and the various types of risk they undertake (including their leverage, their lending risk, and their interest rate risk). The model also allows for heterogeneous bank income streams, dividend signaling effects, and changes in capitalization rates for income streams over time depending on changing market conditions. This approach explains substantial cross-sectional variation in observed market-to-book values, allowing us to identify the market pricing of various banking activities and changes in market pricing over time. We find that the declines in bank stock values since 2007 reflect declining values of various categories of banking activity and changes in market conditions. Dividend payments matter for market values increasingly over time. "Carry-trade" effects from taking on interest rate risk are also apparent. The effects of leverage on bank valuation changed sign during the crisis; while the market rewarded high leverage with higher market values prior to the crisis, leverage become associated with lower values during and after the crisis. Contrary to the view that the declines in market-to-book values for U.S. banks from 2006-2011 mainly reflect unrecognized losses, we find that other factors explain most of the decline in market-to-book ratios. Although model parameters do change over time, more than three-quarters of the change in market-to-book values that occurred from 2006 to the end of 2008 were predictable based on changes in fundamental determinants of value using the model coefficients estimated in 2006.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17868.

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Date of creation: Feb 2012
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Handle: RePEc:nbr:nberwo:17868
Note: CF
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  1. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
  2. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
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  4. Allen N. Berger & Rebecca S. Demsetz & Philip E. Strahan, 1998. "The consolidation of the financial services industry: causes, consequences, and implications for the future," Finance and Economics Discussion Series 1998-46, Board of Governors of the Federal Reserve System (U.S.).
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  8. Nissim, Doron, 2003. " Reliability of Banks' Fair Value Disclosure for Loans," Review of Quantitative Finance and Accounting, Springer, vol. 20(4), pages 355-84, June.
  9. Huizinga, Harry & Laeven, Luc, 2009. "Accounting discretion of banks during a financial crisis," CEPR Discussion Papers 7381, C.E.P.R. Discussion Papers.
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  11. Ing-Haw Cheng & Harrison Hong & Jose Scheinkman, 2010. "Yesterday's Heroes: Compensation and Creative Risk-Taking," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  12. Jayaratne, Jith & Morgan, Donald P, 2000. "Capital Market Frictions and Deposit Constraints at Banks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(1), pages 74-92, February.
  13. Knaup, M. & Wagner, W.B., 2009. "A Market Based Measure of Credit Quality and Banks' Performance During the Subprime Crisis," Discussion Paper 2009-35 S, Tilburg University, Center for Economic Research.
  14. Laux, Christian & Leuz, Christian, 2009. "Did fair-value accounting contribute to the financial crisis?," CFS Working Paper Series 2009/22, Center for Financial Studies (CFS).
  15. Craig O. Brown & I. Serdar Dinç, 2005. "The Politics of Bank Failures: Evidence from Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 120(4), pages 1413-1444, November.
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  17. Demsetz, Rebecca S & Strahan, Philip E, 1997. "Diversification, Size, and Risk at Bank Holding Companies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 300-313, August.
  18. Penas, Maria Fabiana & Unal, Haluk, 2004. "Gains in bank mergers: Evidence from the bond markets," Journal of Financial Economics, Elsevier, vol. 74(1), pages 149-179, October.
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  22. Charles W. Calomiris & Doron Nissim, 2007. "Activity-Based Valuation of Bank Holding Companies," NBER Working Papers 12918, National Bureau of Economic Research, Inc.
  23. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  24. Joseph P. Hughes & Loretta J. Mester & Choon-Geol Moon, 2000. "Are Scale Economies in Banking Elusive or Illusive?," Departmental Working Papers 200004, Rutgers University, Department of Economics.
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