Bank Risk Dynamics and Distance to Default

Stefan Nagel and Amiyatosh Purnanandam

No 25807, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: G01 G21 G38 (search for similar items in EconPapers)
Date: 2019-05
New Economics Papers: this item is included in nep-ban and nep-rmg
Note: AP CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Published as Stefan Nagel & Amiyatosh Purnanandam & Itay Goldstein, 2020. "Banks’ Risk Dynamics and Distance to Default," The Review of Financial Studies, vol 33(6), pages 2421-2467.

Downloads: (external link)
http://www.nber.org/papers/w25807.pdf (application/pdf)

Related works:
Journal Article: Banks’ Risk Dynamics and Distance to Default (2020)
Working Paper: Bank risk dynamics and distance to default (2019)
Working Paper: Bank Risk Dynamics and Distance to Default (2019)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:25807

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w25807

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().