Equity and Bond Market Signals as Leading Indicators of Bank Fragility

ECB Working Paper No. 150

59 Pages Posted: 24 Jul 2002

See all articles by Reint Gropp

Reint Gropp

Halle Institute for Economic Research

Jukka M. Vesala

Bank of Finland - Finnish Financial Supervision Authority (FIN-FSA)

Giuseppe Vulpes

Unicredit Banca d'Impresa - Research Department; UniCredit

Multiple version iconThere are 2 versions of this paper

Date Written: June 2002

Abstract

We analyse EU banks' equity market-based distances-to-default and subordinated bond spreads in the secondary market in relation to their capability of signalling a material weakening in banks' financial condition. Both indicators are demonstrated to be complete indicators of bank fragility, reflecting relevant information of default risk; and also to be aligned with the supervisors' conservative perspective. We use two different econometric models: a logit-model, estimated for a number of different time-leads, and a Cox proportional hazard model. We find support in favour of using both the distance-to-default and spread as leading indicators of bank fragility, regardless of our econometric specification. However, while we find robust predictive performance of the distance-to-default between 6 to 18 months in advance, its predictive properties are quite poor closer to the "default" events. In contrast, all banks' subordinated debt spreads seem to have signal value, but close to the "default" events only. Otherwise, they appear to be significantly diluted by the expectation of public bailout, which is not the case with the equity market-based distances-to-default.

Keywords: Banking, Bank fragility, Market Indicators

JEL Classification: G21, G12

Suggested Citation

Gropp, Reint and Vesala, Jukka and Vulpes, Giuseppe and Vulpes, Giuseppe, Equity and Bond Market Signals as Leading Indicators of Bank Fragility (June 2002). ECB Working Paper No. 150, Available at SSRN: https://ssrn.com/abstract=318359 or http://dx.doi.org/10.2139/ssrn.318359

Reint Gropp

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

Jukka Vesala

Bank of Finland - Finnish Financial Supervision Authority (FIN-FSA) ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

Giuseppe Vulpes (Contact Author)

Unicredit Banca d'Impresa - Research Department ( email )

Via S. Prospero 1
Milan, 20121
Italy
+39-0288622315 (Phone)
+39-028862448 (Fax)

HOME PAGE: www.unicreditimpresa.it

UniCredit ( email )

Via S. Prospero 1
Milan, 20121
Italy
+39-0288622315 (Phone)
+39-028862448 (Fax)

HOME PAGE: www.unicreditimpresa.it

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