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

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

Research output: Contribution to journalArticle

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 languageEnglish
Pages (from-to) 991-1008
Number of pages18
JournalJournal of Business Finance and Accounting
Volume40
Issue number7-8
DOIs
StatePublished - Sep 2013

Keywords

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

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