The End of Market Discipline? Investor Expectations of Implicit State Guarantees
Viral V. Acharya
New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance
Virginia Tech Pamplin Business School; World Bank - Financial and Private Sector Development
A. Joseph Warburton
Syracuse University - College of Law; Syracuse University - Whitman School of Management
We find that bondholders of major financial institutions have an expectation that the government will shield them from losses and, as a result, they do not accurately price risk. While bond credit spreads are sensitive to risk for most financial institutions, credit spreads lack risk sensitivity for the largest institutions. This expectation of public support constitutes a subsidy to large financial institutions, allowing them to borrow at government-subsidized rates. We find that passage of Dodd-Frank did not eliminate expectations of government support. The issue of too-big-to-fail remains unresolved.
Number of Pages in PDF File: 61
Keywords: Banking, too big to fail, too-big-to-fail, TBTF, financial institutions, financial crisis, safety net subsidy, bailout, implicit subsidy, implicit guarantee, government guarantee, public guarantee, state guarantee, asymmetric guarantee, conjectural guarantee, moral hazard, systemic risk
JEL Classification: G21, G24, G28working papers series
Date posted: November 19, 2011 ; Last revised: December 29, 2013
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