This paper examines the ability of stock market investors to monitor bank risk for a sample of listed banks in Tunisia and Morocco over the period 2003-2009. We construct numerous market-based risk measures: market beta, idiosyncratic risk component and total volatility of bank stock returns derived from the market model as well as the distance-to-default derived from the structural model of credit risk. Using a panel data analysis, we show that market-based measures of risk are strongly associated to bank fundamental characteristics. This finding has important implications for regulators as shareholders are able to assess bank financial condition and hence exert effective discipline on bank risk-taking behavior.
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