Book-to-Market Equity, Asset Correlations and the Basel Capital Requirement

Cheng-Shih Lee; Chien-Ting Lin; Min-Teh Yu

doi:10.1111/jbfa.12029

Book-to-Market Equity, Asset Correlations and the Basel Capital Requirement

Cheng-Shih Lee, Chien-Ting Lin, Min-Teh Yu

Department of Information Management and Finance

Research output: Contribution to journal › Article › peer-review

3 Scopus citations

Abstract

This paper examines the effect of book-to-market equity (BE/ME) on asset correlations under the Basel capital requirement. We find that BE/ME captures variations in asset correlations after controlling for firm size, default probability and industry effects from 1987 to 2011. Obligors with higher BE/ME exhibit lower asset correlations compared to those with lower BE/ME. Decomposing BE/ME into assets-in-place and growth options based on the asset pricing literature shows that obligors with more assets-in-place or more fixed assets have higher BE/ME and lower asset correlations than those with more growth options. Overall, our findings suggest that BE/ME is an additional important factor that may improve the estimates of asset correlations and thereby banks' capital adequacy.

Original language	English
Pages (from-to)	991-1008
Number of pages	18
Journal	Journal of Business Finance and Accounting
Volume	40
Issue number	7-8
DOIs	https://doi.org/10.1111/jbfa.12029
State	Published - Sep 2013

Keywords

bank capital requirement; asset correlation; book-to-market equity; firm size; default probability

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10.1111/jbfa.12029

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title = "Book-to-Market Equity, Asset Correlations and the Basel Capital Requirement",

abstract = "This paper examines the effect of book-to-market equity (BE/ME) on asset correlations under the Basel capital requirement. We find that BE/ME captures variations in asset correlations after controlling for firm size, default probability and industry effects from 1987 to 2011. Obligors with higher BE/ME exhibit lower asset correlations compared to those with lower BE/ME. Decomposing BE/ME into assets-in-place and growth options based on the asset pricing literature shows that obligors with more assets-in-place or more fixed assets have higher BE/ME and lower asset correlations than those with more growth options. Overall, our findings suggest that BE/ME is an additional important factor that may improve the estimates of asset correlations and thereby banks' capital adequacy.",

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