Description

Traditional approaches to assess the default risk of a bank fail to recognize their basic operations, granting loans and receiving deposits from the public. The contingent clai ms approach (CCA) is an extension of the Black-Scholes (1973) and Me rton (1974) models that calculate the credit risk of a company by characterizing the company’s equity as a call option on its assets. Although a bank can be understood as a firm, banks receive deposits and unlike a common debt, these have to be renewed before the maturity of the assets.
This paper proposes a new approach to measure the default risk of a bank based on the CCA, but it includes a stochastic distress barrier in order to capture the funding volatility of the bank. This new framework provides a method to calcu late the implied volatility the bank ’s assets and their corresponding distance to distress (DD) and the correlatio n between assets and deposits returns.
This methodology is applied to the Chilean banking system in the period of 2003-2012. The results show that there was an important decrease of the DD that coincides with the increment in the funding volatility during the recent crisis