Bank Capital and Bank Stock Performance1

How does bank capital affect bank stock returns? We empirically examine this question by distinguishing between performance in bad times and other times. After controlling for the risk components of bank stock returns, we find strong evidence that high-capital banks exhibit better stock performance than low-capital banks in bad times, but there is no difference in other times. Results hold both in sample and out of sample. Trading strategies formulated based on bank capital and economic regimes yield significantly positive (abnormal) risk-adjusted returns. The results are robust to a variety of alternative specifications, including different definitions of banks, capital ratios, and bad times, and the use of alternative asset pricing models. JEL Classification: G12, G20, G28