Comment

where the franchise value is the difference between the fair and book value of bank equity. The franchise value is positive when banks can increase the value of their assets above their costs, as captured by the book value, or when banks have a funding advantage. A clever application of a standard valuation technique in finance, the Gordon growthmodel, allows the authors to calculate the model-implied market-to-book ratio and the franchise value of the aggregate US banking sector. The inputs to the model are simply a discount rate, the cash flow to bank equity, and a cash flow growth rate. This method is accurate as long as its inputs accurately capture the cash flow process, the risk, and the opportunity cost of capital for bank equity investors. Using bank accounting data and corporate excess return data, the authors calculate banks’model implied franchise value and market-to-book ratio, that is, two of the three terms in the above equation. They conclude that the reduction in bank market valuation is primarily due to a reduction in the value of government guarantees. In my comments, I first present a simplified version of the valuation method to highlight the authors’ key assumptions. Second, I present evidence that banks are exposed to interest rate risk, leading me to argue that interest rate risk should be taken into account for amore compelling