Too-Systemic-To-Fail: What Option Markets Imply About Sector-Wide Government Guarantees

70 Pages Posted: 15 Feb 2011 Last revised: 14 Nov 2015

See all articles by Bryan T. Kelly

Bryan T. Kelly

Yale SOM; AQR Capital Management, LLC; National Bureau of Economic Research (NBER)

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); New York University Stern School of Business, Department of Finance

Multiple version iconThere are 5 versions of this paper

Date Written: October 30, 2015

Abstract

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.

Keywords: systemic risk, too-big-to-fail, option pricing, government bailout, financial disaster models

JEL Classification: G12, G13, G18, G21, G28, E44, E60, H23

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 (October 30, 2015). American Economic Review, Forthcoming; Fama-Miller Working Paper; Chicago Booth Research Paper No. 11-12. Available at SSRN: https://ssrn.com/abstract=1762312 or http://dx.doi.org/10.2139/ssrn.1762312

Bryan T. Kelly

Yale SOM ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
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3108716532 (Phone)

National Bureau of Economic Research (NBER)

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Stijn Van Nieuwerburgh (Contact Author)

Columbia University Graduate School of Business ( email )

3022 Broadway
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United States

HOME PAGE: http://https://www0.gsb.columbia.edu/faculty/svannieuwerburgh/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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

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