Market Discipline and the Use of Stock Market Data to Predict Bank Financial Distress

by Isabelle Distinguin of the Université de Limoges,
Philippe Rous of the Université de Limoges, and
Amine Tarazi of the Université de Limoges

October 2006

Abstract: We assess the extent to which stock market information can be used to estimate leading indicators of bank financial distress. We specify a logit early warning model, designed for European banks, which tests if market based indicators add predictive value to models relying on accounting data. We also study the robustness of the link between market information and financial downgrading in the light of the safety net and asymmetric information hypotheses. Some of our results support the use of market-related indicators. Other results show that the accuracy of the predictive power depends on the extent to which bank liabilities are market traded.

JEL Classification: G21, G28.

Keywords: bank, market discipline, bank risk, market prices.

Published in: Journal of Financial Services Research, Vol. 30, No. 2, (October 2006), pp. 151-176.

Related reading: Using Securities Market Information for Bank Supervisory Monitoring,
An Early Warning Model for EU Banks with Detection of the Adverse Selection Effect

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