Download this Paper Open PDF in Browser

The Put Problem with Buying Toxic Assets

14 Pages Posted: 15 Feb 2009 Last revised: 6 Jan 2010

Linus Wilson

University of Louisiana at Lafayette - College of Business Administration

Date Written: April 24, 2009

Abstract

This paper uses the option pricing arguments of Merton (1974) to demonstrate that even solvent banks will be reluctant to sell volatile, toxic assets at market prices. Banks' shareholders have insolvency puts that give them limited liability in the event of default. The insolvency puts are more valuable when the banks' assets are more volatile. Shareholders in banks will require any buyer to pay for the lost volatility as well as the market price of the toxic assets. Thus, taxpayers must be ready to richly overpay if they want banks to voluntarily part with their toxic assets.

Keywords: FDICIA, mortgage securities, PPIP, Public Private Investment Partnership, receivership, resolution authority, TARP, too big to fail, toxic assets

JEL Classification: G01, G13, G21, G28, G32

Suggested Citation

Wilson, Linus, The Put Problem with Buying Toxic Assets (April 24, 2009). Applied Financial Economics, Vol. 20, No. 1, 2010. Available at SSRN: https://ssrn.com/abstract=1343625 or http://dx.doi.org/10.2139/ssrn.1343625

Linus Wilson (Contact Author)

University of Louisiana at Lafayette - College of Business Administration ( email )

Department of Economics & Finance
214 Hebrard Blvd., Room 326
Lafayette, LA 70504-0200
United States
(337) 482-6209 (Phone)
(337) 482-6675 (Fax)

HOME PAGE: http://www.linuswilson.com

Paper statistics

Downloads
1,060
Rank
16,468
Abstract Views
10,313