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)
July 31, 2015
AFA 2012 Chicago Meetings Paper
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: 78
Keywords: systemic risk, government bailout, too-big-to-fail, option pricing models, disaster models, financial crisis
JEL Classification: G12, G13, G18, G21, G28, E44, E60, H23
Date posted: March 17, 2011 ; Last revised: August 6, 2015
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