What Do Equity Markets Tell Us About the Drivers of Bank Default Risk? Evidence from Emerging Markets

Abstract

We use the option-based Merton (1974) model to derive the implicit probability of default of 218 banks in 24 emerging economies in the period 1995-2009 from their stock prices. This solvency indicator is well comparable between banks in different countries since it does not require the selection of bank default criteria. Moreover, the implicit default probability is a continuous measure of bank solvency and thus enables us to analyze the emergence of solvency problems of banks over time. Using a panel estimation approach we find that capital adequacy, asset and management quality, profitability, bank size and the engagement in investment banking are the main drivers of bank default risk from the shareholders’ perspective.

Keywords: bank default, risk, Merton model, stock market, emerging markets

JEL Classification: G21, G13, G28