Systemic risk and the market-to-book value of banks' equity

Sammanfattning: The goal of this thesis is to investigate whether market participants considered possible government guarantees when valuing banks' equity before the recent financial crisis and to what extent the market value of banks' equity is useful to estimate their exposure to systemic risk. Using a theoretical approach, we first present our argument that anticipated government guarantees in case of a systemic breakdown lead to financing costs of debt being independent from a bank's exposure to systemic risk. Since debtholders classify their debt repayments as almost riskless due to expected government intervention ("government guarantees") in case of a default in a crisis, they require only little compensation for their contribution. In return, banks increase their exposure to systemic risk to earn additional future cash flows, leading to a higher market-to-book value of their equity. We test this argument by regressing individual banks' average losses on the worst days during the crisis (as a proxy for their systemic risk exposure) on their market-to-book value of equity before the crisis hit. We find a highly significant positive relationship between banks' market value of equity and their exposure to systemic risk. This leads us to the conclusion that first, market participants priced anticipated government guarantees in banks' market value of equity and second, the market-to-book value of a bank is an indicator for its exposure to systemic risk. Several robustness tests support our findings.