Valuation and systemic risk consequences of bank opacity

We examine the effects of opacity on bank valuation and synchronicity in bank equity returns over the years 2000-2006 prior to the 2007 financial crisis. As expected, investments in opaque assets are more profitable than investments in transparent assets, and taking profitability into account, have larger valuation discounts relative to transparent assets. The valuation discounts on opaque asset investments decline over the 2000-2006 period only to be followed by a sharp reversal in 2007. The decline is coincident with a rise in bank equity share prices, decrease in transparent asset holdings by banks, and greater return synchronicity - evidence consistent with a feedback effect.

► Opaque assets are more profitable than transparent assets. ► Taking profitability into account, opaque assets have larger valuation discounts. ► Valuation discounts for opaque assets decline over the 2000-2006 period. ► The decline in valuation discounts for opaque assets produces a feedback effect. ► Overinvestment in opaque assets creates price synchronicity and systemic risk.