Working Papers

2004-19 | November 2004

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Testing the Strong Form of Market Discipline: The Effects of Public Market Signals on Bank Risk

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Under the strong form of market discipline, publicly traded banks that have constantly available public market signals from their stock (and bond) prices would take less risk than non-publicly traded banks because counterparties, borrowers, and regulators could react to adverse public market signals against publicly traded banks. In comparing the credit risk, earnings risk, capitalization, and failure risk between publicly traded and non-publicly traded banks, the evidence in this paper rejects the strong-form of market discipline. In fact, the findings indicate that banking organizations tend to take more risk when they were publicly traded than when they were privately owned.

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