Book‐To‐Market Equity, Asset Correlations and the Basel Capital Requirement

18 Pages Posted: 15 Nov 2013

See all articles by Shih‐Cheng Lee

Shih‐Cheng Lee

Yuan Ze University

Chien‐Ting Lin

Deakin University - School of Accounting, Economics and Finance

Min‐Teh Yu

National Chiao-Tung University; Providence University; National Taiwan University

Date Written: September/October 2013

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.

Keywords:  bank capital requirement, asset correlation, book‐to‐market equity, firm size, default probability

Suggested Citation

Lee, Shih‐Cheng and Lin, Chien‐Ting and Yu, Min-Teh, Book‐To‐Market Equity, Asset Correlations and the Basel Capital Requirement (September/October 2013). Journal of Business Finance & Accounting, Vol. 40, Issue 7-8, pp. 991-1008, 2013, Available at SSRN: https://ssrn.com/abstract=2354733 or http://dx.doi.org/10.1111/jbfa.12029

Shih‐Cheng Lee (Contact Author)

Yuan Ze University

135, Far-East Rd., Chung-Li
Taoyuan, ROC
Taiwan

Chien‐Ting Lin

Deakin University - School of Accounting, Economics and Finance ( email )

221 Burwood Highway
Burwood, Victoria 3215
Australia

Min-Teh Yu

National Chiao-Tung University ( email )

Hsinchu, 30010
Taiwan

Providence University ( email )

HOME PAGE: http://https://sites.google.com/view/mtyu/

National Taiwan University

Department of Geography
Taiwan

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