Using Market Information to Help Identify Distressed Institutions : A Regulatory Perspective

The purpose of this article is to assess the relationship, in timing and magnitude, between equity market valuations of commercial banks and thrift institutions and changes in the supervisory ratings for these organizations. In particular, we ask two questions: to what extent do market variables such as stock prices, returns, and trading volume (among others) provide timely market signals? And if they do provide timely signals, can they add incremental value to off-site monitoring systems that attempt to predict changes in the CAMEL ratings assigned by regulators? We begin to address these questions by discussing the institutional setting for the downgrading of a bank's CAMEL rating. We then evaluate problems associated with interpreting market data before examination ratings are changed. Finally, we perform statistical tests to test the incremental predictive content of market-related variables compared with accounting data from bank financial reports