Structural credit risk models in banking with applications to the Financial Crisis

Abstract

OF THE THESIS Structural Credit Risk Models in Banking with Applications to the Financial Crisis by Michael B. Imerman Thesis directors: Professors Ren-Raw Chen and Ben J. Sopranzetti This dissertation uses structural credit risk models to analyze banking institutions during the recent financial crisis. The first essay proposes a dynamic approach to estimating bank capital requirements with a structural credit risk model. The model highlights the fact that static measures of capital adequacy, such as a fixed percentage of assets, do not capture the true condition of a financial institution. Rather, a dynamic approach that is forward-looking and tied to market conditions is more appropriate in setting capital requirements. Furthermore, the structural credit risk model demonstrates how market information and the liability structure can be used to compute default probabilities, which can then be used as a point of reference for setting capital requirements. The results indicate that capital requirements may be timevarying and conditional upon the health of the particular bank and the financial system as