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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


UCLA - Anderson School of Management; 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)

March 21, 2012

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. A large amount of aggregate tail risk is missing from the price of financial sector crash insurance during the financial crisis. The difference in costs of 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, which lowers index put prices far more than those of individual banks, explains the divergence in the basket-index put spread.

Number of Pages in PDF File: 60

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: December 20, 2013

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 (March 21, 2012). 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
UCLA - Anderson School of Management ( email )
405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095
United States
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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