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Distance-to-Default in Banking: A Bridge Too Far?

Author/Editor: Chan-Lau, Jorge A. | Sy, Amadou N. R.
Authorized for Distribution: September 1, 2006
Electronic Access: Free Full Text (PDF file size is 519KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: In contrast to corporate defaults, regulators typically take a number of statutory actions to avoid the large fiscal costs associated with bank defaults. The distance-to-default, a widely used market-based measure of corporate default risk, ignores such regulatory actions. To overcome this limitation, this paper introduces the concept of distance-to-capital that accounts for pre-default regulatory actions such as those in a prompt-corrective-actions framework. We show that both risk measures can be analyzed using the same theoretical framework but differ depending on the level of capital adequacy thresholds and asset volatility. We also use the framework to illustrate pre-default regulatory actions in Japan in 2001-03.
 
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Series: Working Paper No. 06/215
Subject(s): Banks | Financial stability
Author's keyword(s): Banks | insolvency | closure | prompt corrective action | distance-to-default | distance-to-capital
 
English  
    Published:   September 1, 2006        
    ISBN/ISSN:   1934-7073   Format:   Paper
    Stock No:   WPIEA2006215   Pages:   17
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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