Can the Equity Markets Help Predict Bank Failures?
Timothy J. Curry*
Peter J. Elmer**
Gary S. Fissel*
July, 2004
Working Paper 2004-03
*Senior Financial Economist, Division of Insurance and Research, Federal Deposit Insurance
Corporation (FDIC), Washington, DC 20429
**Reston, Virginia 20190
The views expressed here are those of the authors and do not necessarily reflect those of the
FDIC or its staff. The authors would like to thank Audrey Clement for extensive assistance; and
Gerald Hanweck, Andrew Davenport, anonymous referees, and the participants in the 2004
Washington Area Finance Association meetings and the 2004 Western Economic Association
International meetings for helpful comments.
Timothy J. Curry*
Peter J. Elmer**
Gary S. Fissel*
July, 2004
Working Paper 2004-03
*Senior Financial Economist, Division of Insurance and Research, Federal Deposit Insurance
Corporation (FDIC), Washington, DC 20429
**Reston, Virginia 20190
The views expressed here are those of the authors and do not necessarily reflect those of the
FDIC or its staff. The authors would like to thank Audrey Clement for extensive assistance; and
Gerald Hanweck, Andrew Davenport, anonymous referees, and the participants in the 2004
Washington Area Finance Association meetings and the 2004 Western Economic Association
International meetings for helpful comments.
Abstract
The paper examines the informational content of market data when these data are incorporated
into traditional models that predict bank failures. To assess whether financial markets can provide
timely information about firm distress, we first examine the pre-failure behavior of market variables
over long periods before failure. The univariate results document distinct patterns of declining
prices, negative returns, declining dividends, and rising return volatility several years before failure.
Several other market-related measures, however, such as trading volume and share turnover,
show no clear trend. Next we test for the contribution of market variables in relation to Call Report
variables in the prediction of bank failures over the 1989–1995 period. The findings show that
selected market variables like equity prices, returns, and volatility of returns add important
information to the identification of failed institutions beyond the information contained in
quarterly accounting data. In-sample and out-of-sample tests show that the use of market data
does improve the sample forecast of bank failure.
JEL Codes: G21, G28
Keywords: Bank Failure, Market information and Off-site Surveillance Models
1
The paper examines the informational content of market data when these data are incorporated
into traditional models that predict bank failures. To assess whether financial markets can provide
timely information about firm distress, we first examine the pre-failure behavior of market variables
over long periods before failure. The univariate results document distinct patterns of declining
prices, negative returns, declining dividends, and rising return volatility several years before failure.
Several other market-related measures, however, such as trading volume and share turnover,
show no clear trend. Next we test for the contribution of market variables in relation to Call Report
variables in the prediction of bank failures over the 1989–1995 period. The findings show that
selected market variables like equity prices, returns, and volatility of returns add important
information to the identification of failed institutions beyond the information contained in
quarterly accounting data. In-sample and out-of-sample tests show that the use of market data
does improve the sample forecast of bank failure.
JEL Codes: G21, G28
Keywords: Bank Failure, Market information and Off-site Surveillance Models
1