Modeling Structural and Temporal Variation in the Market's Valuation of Banking Firms

Abstract

ABSTRACT Hidden capital exists whenever the accounting measure of a firm's net worth diverges from its economic value. Such unbooked capital has on‐balance‐sheet and off‐balance‐sheet sources. This paper develops a model to estimate both forms of hidden capital and to test hypotheses about their determinants. In effect, the analysis expands the two‐index model by endogenizing the market and interest‐rate sensitivities of any stock and decomposing each sensitivity into on‐balance‐sheet and off‐balance‐sheet elements. For a sample of banks during 1975–1985, the model finds considerable variation in both forms of hidden capital.

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