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.
- bank capital requirement; asset correlation; book-to-market equity; firm size; default probability
Lee, C-S., Lin, C-T., & Yu, M-T. (2013). Book-to-Market Equity, Asset Correlations and the Basel Capital Requirement. Journal of Business Finance and Accounting, 40(7-8), 991-1008. https://doi.org/10.1111/jbfa.12029