Get access

EFFECT OF FED POLICY ACTIONS ON THE DEFAULT LIKELIHOOD OF COMMERCIAL BANKS

Authors


  • The authors would like to thank the reviewer, Sorin M. Sorescu of Texas A&M University, for his valuable comments and suggestions. They would also like to gratefully acknowledge financial support from the Moyer endowment at the University of Akron and the Theis endowment at St. John's University.

Abstract

Using a measure of default likelihood based on an option pricing method, we provide evidence that Fed policy actions affect the financial distress of commercial banks. When the Fed increases (decreases) interest rates, the measure of default likelihood increases (decreases). We show that when the Fed uses a tight money policy, the increase in default likelihood is more pronounced for banks that have less capital, have greater financial leverage, are smaller, have fewer growth opportunities, and have lower asset quality. Additionally, the effects on bank default likelihood are more pronounced when the Fed's policy signals less concern about economic growth, as indicated by its bias toward further tightening, and when there is a market expectation of higher short-term market rates in the future.

Ancillary