A capital adequacy buffer model

D. E. Allen, M. McAleer, R. J. Powell, A. K. Singh

Research output: Contribution to journalArticleResearchpeer-review

Abstract

We develop a new capital adequacy buffer model (CABM) that is sensitive to dynamic economic circumstances. The model, which measures additional bank capital required to compensate for fluctuating credit risk, is a novel combination of the Merton structural model, which measures distance to default and the timeless capital asset pricing model (CAPM), which measures additional returns to compensate for additional share price risk. We apply the model to a portfolio of mid-cap loan assets over a 10-year period that includes pre-GFC (global financial crisis), GFC and post-GFC. An analysis of actual defaults over this period shows the model to be far more accurate in determining the capital adequacy levels needed to counter credit risk than an unresponsive ratings model such as the Basel standardized approach.

LanguageEnglish
Pages175-179
Number of pages5
JournalApplied Economics Letters
Volume23
Issue number3
DOIs
Publication statusPublished - 11 Feb 2016
Externally publishedYes

Fingerprint

Capital adequacy
Buffer
Credit risk
Assets
Distance measure
Share prices
Capital asset pricing model
Rating
Structural model
Loans
Global financial crisis
Economic dynamics
Price risk
Bank capital
Basel

Keywords

  • capital adequacy buffer model
  • capital buffer
  • Credit risk
  • distance to default

Cite this

Allen, D. E. ; McAleer, M. ; Powell, R. J. ; Singh, A. K. / A capital adequacy buffer model. In: Applied Economics Letters. 2016 ; Vol. 23, No. 3. pp. 175-179.
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A capital adequacy buffer model. / Allen, D. E.; McAleer, M.; Powell, R. J.; Singh, A. K.

In: Applied Economics Letters, Vol. 23, No. 3, 11.02.2016, p. 175-179.

Research output: Contribution to journalArticleResearchpeer-review

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