Optimal Bank Capital with Costly Recapitalization

49 Pages Posted: 21 Dec 2004  

Samu Peura

Sampo Bank

Jussi Keppo

National University of Singapore - NUS Business School

Multiple version iconThere are 2 versions of this paper

Date Written: February 4, 2005

Abstract

We study optimal bank capital choice as a dynamic tradeoff between the opportunity cost of equity, the loss of franchise value following a regulatory minimum capital violation, and the cost of recapitalization. We introduce a recapitalization delay, which results in a strictly positive probability of capital adequacy violation and qualitatively influences optimal capital raising policies. We calibrate the model to bank accounting return data and evaluate the model's ability to explain observed bank capital ratios. Differences in return volatility explain a significant fraction of the cross-sectional variation in bank capital ratios. Differences in the level of capital market imperfections across banks constitute a secondary explanation. Our analysis points to the need for improved forward looking estimates of bank return volatility.

Note: Previously titled "Optimal Capital Management with Fixed Costs and Implementation Delays"

Keywords: bank capital, dividends, capital issues, fixed cost, delay

JEL Classification: G32, G35

Suggested Citation

Peura, Samu and Keppo, Jussi, Optimal Bank Capital with Costly Recapitalization (February 4, 2005). AFA 2005 Philadelphia Meetings; EFMA 2003 Helsinki Meetings. Available at SSRN: https://ssrn.com/abstract=318347 or http://dx.doi.org/10.2139/ssrn.318347

Samu Peura (Contact Author)

Sampo Bank ( email )

Unioninkatu 22, Helsinki
P.O.Box 1026, FI-00075 SAMPO
Finland
+358 10 513 4325 (Phone)

Jussi Keppo

National University of Singapore - NUS Business School ( email )

1 Business Link
Singapore, 117592
Singapore

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