Abstract

http://ssrn.com/abstract=1762312
 
 

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Too-Systemic-To-Fail: What Option Markets Imply About Sector-Wide Government Guarantees


Bryan T. Kelly


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Hanno N. Lustig


Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Stijn Van Nieuwerburgh


New York University Stern School of Business, Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

October 30, 2015

American Economic Review, Forthcoming
Fama-Miller Working Paper
Chicago Booth Research Paper No. 11-12

Abstract:     
We examine the pricing of financial crash insurance during the 2007-2009 financial crisis in U.S. option markets, and we show that a large amount of aggregate tail risk is missing from the cost of financial sector crash insurance during the crisis. The difference in costs between out-of-the-money put options for individual banks and puts on the financial sector index increases fourfold from its pre-crisis 2003-2007 level. We provide evidence that a collective government guarantee for the financial sector lowers index put prices far more than those of individual banks and explains the increase in the basket-index put spread.

Number of Pages in PDF File: 70

Keywords: systemic risk, too-big-to-fail, option pricing, government bailout, financial disaster models

JEL Classification: G12, G13, G18, G21, G28, E44, E60, H23


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Date posted: February 15, 2011 ; Last revised: November 14, 2015

Suggested Citation

Kelly, Bryan T. and Lustig, Hanno N. and Van Nieuwerburgh, Stijn, Too-Systemic-To-Fail: What Option Markets Imply About Sector-Wide Government Guarantees (October 30, 2015). American Economic Review, Forthcoming; Fama-Miller Working Paper; Chicago Booth Research Paper No. 11-12. Available at SSRN: http://ssrn.com/abstract=1762312 or http://dx.doi.org/10.2139/ssrn.1762312

Contact Information

Bryan T. Kelly
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-8359 (Phone)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Hanno N. Lustig
Stanford Graduate School of Business ( email )
Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Stijn Van Nieuwerburgh (Contact Author)
New York University Stern School of Business, Department of Finance ( email )
44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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