PREDICTING BANK FINANCIAL DISTRESS USING EQUITY MARKET SIGNALS: A REVIEW OF EAST ASIAN EMPIRICAL EVIDENCE

Abstract

In this paper, I examine if equity market signals, including the equity market based distance to default, turnover ratio and cumulative returns, can signal bank distress in a sample of East Asian banks during the period 2001 to 2005. Using logistic regression models, I find the turnover ratio is an inappropriate indicator of fragility, while the distance to default and cumulative return measures are better indicators of bank distress. The distance to default measure also performs poorer at a date closer to the downgrade, while the cumulative returns performs better for less distant prediction. I obtained similar results after macroeconomic and size factors were controlled for. However, I found that the power of prediction power of these two indicators is sensitive to the accuracy level. They fail to identify the downgraded banks at high level of accuracy