How Does Distress Acquisition Incentivized by Government Purchases of Distressed Loans Affect Bank Default Risk?

Jyh-Jiuan Lin, Chuen-Ping Chang and Shi Chen
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Jyh-Jiuan Lin: Department of Statistics, Tamkang University, New Taipei City 25137, Taiwan
Chuen-Ping Chang: Department of Wealth and Taxation Management, National Kaohsiung University of Science and Technology, Kaohsiung City 82444, Taiwan
Shi Chen: School of Economics, Southwestern University of Finance and Economics, Chengdu 611130, China

Risks, 2018, vol. 6, issue 2, 1-16

Abstract: The topic of bank default risk in connection with government bailouts has recently attracted a great deal of attention. In this paper, the question of how a bank’s default risk is affected by a distress acquisition is investigated. Specifically, the government provides a bailout program of distressed loan purchases for a strong bank to acquire a bank in distress. The acquirer bank may likely refuse the acquisition with a bailout when the amount of distressed loan purchases is large or the knock-out value of the acquired bank is high. When the acquirer bank realizes acquisition gains, the default risk in the consolidated bank’s equity return is negatively related to loan purchases, but positively to the knock-out value of the acquired bank. The government bailout, as such, in large part contributes to banking stability.

Keywords: distress acquisition; loan purchases; default risk; barrier option (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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