Bank Risk Dynamics and Distance to Default / Stefan Nagel, Amiyatosh Purnanandam.

Format:

Book

Author/Creator:

Nagel, Stefan.

Contributor:

National Bureau of Economic Research.

Purnanandam, Amiyatosh.

Series:

Working Paper Series (National Bureau of Economic Research) no. w25807.

NBER working paper series no. w25807

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2019.

Summary:

We adapt structural models of default risk to take into account the special nature of bank assets. The usual assumption of log-normally distributed asset values is not appropriate for banks. Typical bank assets are risky debt claims, which implies that they embed a short put option on the borrowers' assets, leading to a concave payoff. This has important consequences for banks' risk dynamics and distance to default estimation. Due to the payoff non-linearity, bank asset volatility rises following negative shocks to borrower asset values. As a result, standard structural models in which the asset volatility is assumed to be constant can severely understate banks' default risk in good times when asset values are high. Bank equity payoffs resemble a mezzanine claim rather than a call option. Bank equity return volatility is therefore much more sensitive to big negative shocks to asset values than in standard structural models.

Notes:

Print version record

May 2019.