@article{f2606bb9cb6e4bc186b313b9b5c0475f,
title = "Opaque bank assets and optimal equity capital",
abstract = "Banks{\textquoteright} assets are opaque, and therefore, we model their true accounting asset values as partially observed variables. We derive a stochastic control model to optimize banks{\textquoteright} dividend and recapitalization policies in this situation, and calibrate that to a sample of U.S. banks. By the calibrated model, the noise in reported accounting asset values hides about one-third of the true asset return volatility and raises the banks{\textquoteright} market equity value by 7.8%. Particularly, those banks with a high level of loan loss provisions, nonperforming assets, and real estate loans, and with a low volatility of reported total assets have noisy accounting asset values. Because of the substantial shock on the true asset values, the banks{\textquoteright} assets were more opaque during the recent financial crisis.",
keywords = "Bank capital, Banking regulation, Dividends, Earnings smoothing, Investment",
author = "Min Dai and Shan Huang and Jussi Keppo",
note = "Funding Information: We thank Sugato Bhattacharyya, Nan Chen, Jin-Chuan Duan, Andrew Papanicolaou, Esa Jokivuolle, Robert Kimmel, Steven Kou, Yue Kuen Kwok, Pauli Murto, Xianhua Peng, Xuchuan Yuan, Zhiwen Wang, and Lixin Wu for useful feedback. We acknowledge the comments from the seminar participants at Hong Kong University of Science and Technology, University of Michigan, Risk Management Institute at NUS, Bank of Finland, Berlin-Princeton-Singapore Workshop on Quantitive Finance, 9th World Conference of the Bachelier Finance Society, and Interdisciplinary Approaches to Financial Stability Conference (University of Michigan). We thankfully acknowledge financial support from the Singapore Ministry of Education, the Institute of Operations Research and Analytics (National University of Singapore), and the National Natural Science Foundation of China under grants R-314-000-097-133, R-146-000-243-114, R-703-000-032-112, WBS-R-726-000-009-646, and NSFC 11671292. Any opinions, findings and conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of the Singapore Ministry of Education, the Institute of Operations Research and Analytics, and the National Natural Science Foundation of China. Publisher Copyright: {\textcopyright} 2019 Elsevier B.V.",
year = "2019",
month = mar,
doi = "10.1016/j.jedc.2019.01.005",
language = "English",
volume = "100",
pages = "369--394",
journal = "Journal of Economic Dynamics and Control",
issn = "0165-1889",
publisher = "Elsevier B.V.",
}