Impact of Transaction Costs on Bank Equity in Fuzzy Financial Markets

Abstract

Recent firm valuation studies have provided insights and extra analysis that option pricing models (OPMs) such as Merton and Black-Scholes can achieve when uncertainty is modelled through fuzzy numbers. This study proposed a KMV asset valuation model (AVM) extended for both transaction costs and uncertainty for valuation of banks in fuzzy financial markets. The research is intended to fill the gaps in structural AVMs, such as their nature of being applicable to frictionless financial markets under precise variables. While a number of recent structural AVMs for banks and similar firms have been adjusted for fuzziness, none of them have managed to capture transaction costs. By applying multiple linear regression techniques under the fuzzy extension principle, we used panel data of eight banks in fuzzy financial markets to generate fuzzy asset values and volatilities using a STATA package. The study concluded that both transaction costs and uncertainty impact the equity values of banks and also increased rigour, precision and estimation accuracy compared to structural models. The paper recommends that banks in fuzzy financial markets can adopt valuation models extended for both uncertainty and transaction costs in their quest to accurately and precisely estimate their equity values.