Abstract

We study optimal bank capital holdings in a dynamic setting where the bank has access to external capital, but this access is subject to a fixed cost and a delay. Our model indicates that a recapitalization option may be valuable despite substantial fixed costs, and that a significant fraction of the value of low capitalized banks may be attributable to the option to recapitalize. When calibrated to data on actual bank returns, the model yields capital ratios that are significantly lower than actual bank capital ratios. This shortfall is, at least partly, explained by the skewness of the distribution of actual bank returns and by the banks ' accounting options for the provisioning of credit losses. We operate the model with implied bank return volatilities, in the same way as Black-Scholes model is used in practice. Analysis of the limiting cases where the capital market imperfections vanish reveals that the capital issue delay rather than the fixed cost determines the qualitative nature of the solution.

Citations