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Optimal Bank Capital with Costly Recapitalization

Author

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  • Samu Peura

    (Sampo Bank)

  • Jussi Keppo

    (University of Michigan)

Abstract

We study optimal bank capital choice as a dynamic trade-off between the opportunity cost of equity, the loss of franchise value following a regulatory minimum capital violation, and the cost of recapitalization. We introduce a recapitalization delay that results in a strictly positive probability of capital adequacy violation. We calibrate the model to bank accounting return data and evaluate the model's ability to explain observed bank capital ratios. Differences in return volatility explain a significant fraction of the cross-sectional variation in bank capital ratios. Differences in the level of capital market imperfections across banks constitute a secondary explanation.

Suggested Citation

  • Samu Peura & Jussi Keppo, 2006. "Optimal Bank Capital with Costly Recapitalization," The Journal of Business, University of Chicago Press, vol. 79(4), pages 2163-2202, July.
    • Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:4:p:2163-2202
    DOI: 10.1086/503660
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