The End of Market Discipline? Investor Expectations of Implicit Government Guarantees
Viral V. Acharya
New York University - Leonard N. Stern School of Business; Centre for International Finance and Regulation (CIFR); 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
June 1, 2014
We find that bondholders of major financial institutions have an expectation that the government will shield them from large financial losses and, as a result, they do not accurately price risk. Using bonds traded in the U.S. between 1990 and 2012, and using alternative approaches to address endogeneity, we find that bond credit spreads are sensitive to risk for most financial institutions, but not for the largest institutions. This expectation of government support constitutes a subsidy to large financial institutions, allowing them to borrow at lower rates. Recent financial regulations that seek to address too-big-to-fail have not had a significant impact in eliminating expectations of government support.
Number of Pages in PDF File: 64
Keywords: Too big to fail, financial crisis, Dodd-Frank, bailout, implicit guarantee, moral hazard, systemic risk
JEL Classification: G21, G24, G28working papers series
Date posted: November 19, 2011 ; Last revised: June 25, 2014
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