Open AccessMarket Discipline in Commercial Banking: Evidence from the Market for Bank Equity
Author(s) -
Ayesha Afzal,
Nawazish Mirza
Publication year - 2011
Publication title -
the lahore journal of economics
Language(s) - English
Resource type - Journals
eISSN - 1811-5446
pISSN - 1811-5438
DOI - 10.35536/lje.2011.v16.isp.a10
Subject(s) - market risk , market discipline , economics , equity (law) , financial risk management , actuarial science , credit risk , business , risk management , probability of default , financial economics , econometrics , finance , political science , law
This study presents empirical evidence of market discipline, using a paneldataset of listed banks on the Karachi Stock Exchange. We construct multiple riskbasedmeasures from the stock prices between 2004 and 2009 to determine whetheran increase in the risk profile results in an increase in compensation for depositorsand other creditors. The risk variables used include market risk, value at risk, sizeand value premium, default likelihood indicator, price relatives, and a controlvariable representing gross domestic product growth. We find a significantrelationship between our risk factors and cost of deposits, indicating that banksalign deposit compensation with their risk perception. However, we cannot find alink between the market perception of risk and deposit switching. These findingshave important implications for policymakers as market discipline couldcomplement the state’s regulatory role and lower the cost of supervision. Ourestimations of value at risk and the default likelihood indicator using stochasticsimulations is a methodological contribution that could be used for effective riskmanagement practices.