An Option-Based Approach to Bank Vulnerabilities in Emerging Markets

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An Option-Based Approach to Bank Vulnerabilities in Emerging Markets

by Jorge A. Chan-Lau of the International Monetary Fund,
Arnaud Jobert of the International Monetary Fund, and
Janet Kong of the International Monetary Fund

February 2004

Abstract: We measure bank vulnerability in emerging markets using the distance-to-default, a risk neutral indicator based on Merton's (1974) structural model of credit risk. The indicator is estimated using equity prices and balance-sheet data for 38 banks in 14 emerging market countries. Results show it can predict a bank's credit deterioration up to nine months in advance. The distance-to-default, hence, may prove useful for bank monitoring purposes.

JEL Classification: G12, G15, G21.

Keywords: Distance-to-default, banks, emerging markets.

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