HKS Authors

See citation below for complete author information.

Charles W. Eliot University Professor
Director, Mossavar-Rahmani Center for Business and Government

Abstract

Market measures suggest banks are as risky as they were in the pre-crisis period. This appears attributable to a decrease in bank franchise value, rather than a byproduct of the current low interest rate environment, and cautions about the stability of the financial sector. However, stress test results reveal little cause for concern; in 2017, all 34 stressed institutions in the United States passed the tests, suggesting they will remain well-capitalized in the event of a downturn more severe than the Great Recession. Their passage paved the way for capital disbursements and ignited calls for deregulation. In this paper, we demonstrate that a market-based stress test approach produces results that are significantly less encouraging than the regulatory tests. While a pure market-based stress test is undesirable, we believe it is important to incorporate market information into the stress test methodology to facilitate more credible inferences about bank safety.

Citation

Sarin, Natasha, and Lawrence H. Summers. "On Market-Based Approaches to the Valuation of Capital." June 2018.