Information about bank risk in options prices

Swidler, Steve; Wilcox, John M.

doi:10.1016/s0378-4266(02)00213-3

Cited by 26 publications

(23 citation statements)

References 14 publications

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“…The international evidence suggests that market signals are indeed informative, especially for banks in industrialized countries. Most evidence exists on the US (see Flannery, 1998, for an overview of the early literature and Krainer and Lopez, 2001;Swidler and Wilcox, 2002;Curry, Elmer and Fissel, 2003;Fan, Haubrich, Ritchken and Thomson, 2003 for more recent research). Recent contributions treat European banks (Persson, 2002;Sironi, 2003;Gropp, Vesala and Vulpes, 2006) or Japanese banks (Brewer, Genay, Hunter and Kaufman, 2003).…”

Section: Introductionmentioning

confidence: 99%

Can Bank Supervisors Rely on Market Data? A Critical Assessment from a Swiss Perspective

Birchler

Facchinetti

2007

Swiss J Economics Statistics

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Summary Market data, such as bond spreads or equity price volatility, are a complementary source to bank supervisory information. In Switzerland, meaningful market data are available for a number of banks which constitute a major part of the banking system. Notwithstanding some limitations (biases due to state guarantee for cantonal banks and potential ‘too-big-to-fail’ expectations for big banks) these market data are likely to play a supervisory role in the future. However, once the market expects supervisors to react to market data, these data become endogenous. This may jeopardize the very potential of market data to serve as policy guides.

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Section: Introductionmentioning

confidence: 99%

Can Bank Supervisors Rely on Market Data? A Critical Assessment from a Swiss Perspective

Birchler

Facchinetti

2007

Swiss J Economics Statistics

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“…Swidler and Wilcox (2002) provide evidence that the volatility measure implied by the prices of options on the banks' shares co-varies with the market volatility and this covariance is negatively related with the capital ratio (that is, bank capital reduces the response of implied volatilities to market volatility). They also show that implied volatilities (IVs) have lower root-mean-squared-error forecasts of banks' future share price volatility than effect in the debt market and the endogeneity of the decision to issue bank debt securities.…”

Section: Introductionmentioning

confidence: 95%

“…Swidler and Wilcox (2002) are the first to suggest adding time-varying measures of implied volatility (IV) extracted from option prices to the menu of market-based risk indicators that regulators and supervisors should regularly monitor. They based their policy recommendation on the idea that IVs have lower root-meansquared-error forecasts of banks' future share price volatility than historical volatilities do and hence improve forecasts based solely on historical volatilities.…”

Section: Executive Summarymentioning

confidence: 99%

“…Indeed, as options are highly leveraged contracts, the lower transaction costs are likely to facilitate speculation and improve liquidity, and hence the informational efficiency of the derivative market (see e.g. Swidler and Wilcox, 2002). Moreover, at least for the largest banking organizations, the market for option contracts on bank equity is active, deep, and sufficiently liquid to provide reliable signals to supervisors.…”

Section: Introductionmentioning

confidence: 99%

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Predicting Financial Distress in a High-Stress Financial World: The Role of Option Prices as Bank Risk Metrics

2010

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Abstract:The current financial crisis offers a unique opportunity to investigate the leading properties of market indicators in a stressed environment and their usefulness from a banking supervision perspective. One pool of relevant information that has been little explored in the empirical literature is the market for bank's exchange-traded option contracts. In this paper, we first extract implied volatility indicators from the prices of the most actively traded option contracts on financial firms' equity. We then examine empirically their ability to predict financial distress by applying survival analysis techniques to a sample of large US financial firms. We find that market indicators extracted from option prices significantly explain the survival time of troubled financial firms and do a better job in predicting financial distress than other time-varying covariates typically included2 in2 bank2 failure2 mo2 dels.2 Overall,2 b2 oth2 accounting2 information2 and2 option2 prices contain useful information of subsequent financial problems and, more importantly, the combination produces good forecasts in a high-stress financial world, full of doubts and uncertainties.Keywords: Financial distress; Financial system oversight; Market discipline; Options; Implied volatility; Survival analysis JEL Codes: G21; G28 BothA theoreticalA andA empiricalA literatureA convincinglyA argueA thatA privateA marketA participants (shareholders, debtholders, large counterparts in derivative markets. . . ) are able to fairly identify risky institutions when the financial system is in good shape. This result is based on the quality of the Hayekian information disseminating process accompanying the price formation alchemy. At the same time, there is a broad consensus that market signals often become erratic and extremely volatile during times of stress, when investors face severe aggregate shocks and markets may stop functioning because systemic risk is at stake. The global financial crisis that broke out in the Summer 2007 provides a unique opportunity to test directly the validity of such a broad consensus and to investigate the leading properties of market signals in a highly stressed environment, characterized by a significant number of real-life failure episodes in the financial services industry.In this paper, we pursue this new direction in the empirical literature and focus on a potential source of information that has been overlooked so far in this research area: the market for exchange-traded option contracts on financial firms' equity. Swidler and Wilcox (2002) are the first to suggest adding time-varying measures of implied volatility (IV) extracted from option prices to the menu of market-based risk indicators that regulators and supervisors should regularly monitor. They based their policy recommendation on the idea that IVs have lower root-meansquared-error forecasts of banks' future share price volatility than historical volatilities do and hence improve forecasts based solely on historical volatilities. They also show ...

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“…Swidler and Wilcox (2002) broaden the set of assets to include equity options. They demonstrate that implied volatility is a good predictor of future realized volatility and conclude that it also has a signalling function for bank risk.…”

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confidence: 99%

Financial Stability in European Banking: The Role of Common Factors

Kool

2006

Open Econ Rev

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In this paper, I investigate the development and determinants of CDS spreads for 18 major European banks between December 2001 and January 2004 applying factor analysis to daily data. Two clear-cut conclusions can be drawn. First, the dominating first common factor that explains 88 percent of all variation in the system, impacts on all banks in a similar direction. This suggests a strong market integration. However the size of the response of each bank's CDS spread to the first common factor differs substantially, probably reflecting differences in individual bank's exposure and riskiness. Second, the first common factor appears significantly related to the European P/E ratio and the European-wide 2-year nominal interest rate. This finding suggests that the common factor may be interpreted as a general indicator of market conditions.

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Information about bank risk in options prices

Cited by 26 publications

References 14 publications

Can Bank Supervisors Rely on Market Data? A Critical Assessment from a Swiss Perspective

Can Bank Supervisors Rely on Market Data? A Critical Assessment from a Swiss Perspective

Predicting Financial Distress in a High-Stress Financial World: The Role of Option Prices as Bank Risk Metrics

Financial Stability in European Banking: The Role of Common Factors

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