Forbearance, Prompt Closure, and the Valuation of Bank Subordinated Debt

33 Pages Posted: 2 Oct 2012

See all articles by Yehning Chen

Yehning Chen

National Taiwan University

Jin-Ping Lee

Feng Chia University

Min‐Teh Yu

National Chiao-Tung University

Date Written: September 5, 2012

Abstract

This study develops a multi-period structural model to value bank subordinated debt (subdebt) under different regulatory policies. The model provides a complete framework for analyzing how various factors, such as credit and interest rate risks, bank characteristics and regulatory policies affect subdebt prices and yield spreads. It finds that the implementation of prompt corrective action (PCA) will raise subdebt prices and lower subdebt spreads, while capital forbearance will have the opposite effects. Also, subdebt spreads are less sensitive to bank risk when PCA is imposed than when capital forbearance occurs. The results of the paper suggest that enhancing market discipline through giving subdebt investors more rights to force timely reorganization of weak banks will reduce the subdebt spreads required by investors.

Keywords: bank subordinated debt, prompt corrective action, capital forbearance, moral hazard, contingent claim analysis

JEL Classification: G20, G28, G21

Suggested Citation

Chen, Yehning and Lee, Jin-Ping and Yu, Min-Teh, Forbearance, Prompt Closure, and the Valuation of Bank Subordinated Debt (September 5, 2012). Midwest Finance Association 2013 Annual Meeting Paper. Available at SSRN: https://ssrn.com/abstract=2142259 or http://dx.doi.org/10.2139/ssrn.2142259

Yehning Chen

National Taiwan University ( email )

1 Sec. 4, Roosevelt Road
Taipei, 106
Taiwan

Jin-Ping Lee

Feng Chia University ( email )

100 Wenhwa Road
Talchung
Taiwan
886-4-24517250ext.4160 (Phone)
886-4-24513796 (Fax)

Min-Teh Yu (Contact Author)

National Chiao-Tung University ( email )

Hsinchu, 30010
Taiwan

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