Bank Capital and Bank Stock Performance

Abstract

Little is known about how bank capital affects bank stock performance. We show that capital does not affect returns unconditionally, but high-capital banks have higher risk-adjusted stock returns (alphas) than low-capital banks in bad times in and out of sample. Trading strategies earn 3.60%–4.44% annually. The results are robust to: using different bad times and capital definitions, alternative asset pricing models, and ex-ante expected returns; controlling for performance-type delistings, short-sale constraints, and trading costs; and dropping the largest or smallest banks. Our results seem to be driven by a “Surprised Investor Channel” rather than by an “Informed Investor Channel.”