Estimating Fair Capital Holdings with Stochastic Interest Rates for Banks in Taiwan

10.29973/JCSA.200606.0003

Hwei-Lin Chuang；Shih-Cheng Lee；Mei-Chi Wu

Bank Capital ； Deposit Insurance ； Stochastic Interest Rates ； Option Pricing

中國統計學報

44卷2期（2006 / 06 / 01）

145 - 170

英文

This study estimates the fair capital holdings implied by the current deposit insurance premiums for banks in Taiwan. We adopt the deposit-insurance model with stochastic interest rates and develop a two-step approach, combining a MLE and a simultaneous-equation system, to solve the implied capital. The empirical results for the time period from 1991 to 2002 indicate that all types of banks, government or private, large or small, old or new, are generally under-capitalized at current deposit insurance premiums. The amount of estimated capital infusion required for most banks is higher under the stochastic interest rate than that under the constant interest rate. Moreover, there is an identification issue for estimating the risk factor effect under the constant interest rate model due to the opposite direction of the effect of the interest rate risk and the credit risk on the capital requirement. Therefore, it is crucial to distinguish the interest rate risk and credit risk in order to correctly identify the risk factor effect on the capital requirement.

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