Re-Examining the Role of Market Discipline for Bank Supervision: Evidence from the Subprime Crisis

40 Pages Posted: 20 Apr 2010 Last revised: 27 Jan 2011

See all articles by Ajay A. Palvia

Ajay A. Palvia

FDIC, Division of Insurance and Research

Dilip K. Patro

OCC

Date Written: January 25, 2011

Abstract

We reexamine the effectiveness of markets in monitoring bank riskiness using a panel of large commercial and investment banks for the period just before and during the subprime financial crises. We find that market based bank specific indicators such as credit default swap premiums, implied volatilities of equity options, credit ratings from rating firms, short interest and equity analysts’ recommendations were informative about future cross-sectional bank performance. Therefore, our panel analysis supports the view that markets are able to distinguish between risky and less risky banks reinforcing the role of ‘market discipline’ as one of the pillars of bank supervision.

Keywords: Market Discipline, Risk, Bank Supervision

JEL Classification: G20, G28

Suggested Citation

Palvia, Ajay A. and Patro, Dilip K., Re-Examining the Role of Market Discipline for Bank Supervision: Evidence from the Subprime Crisis (January 25, 2011). Available at SSRN: https://ssrn.com/abstract=1593031 or http://dx.doi.org/10.2139/ssrn.1593031

Ajay A. Palvia (Contact Author)

FDIC, Division of Insurance and Research ( email )

550 17th Street NW
Washington, DC 20429
United States

Dilip K. Patro

OCC ( email )

400 7th Street SW
Washington, DC 20219
United States
202-649-5548 (Phone)

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