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Bank Rescues and Bailout Expectations: The Erosion of Market Discipline During the Financial Crisis

SAFE Working Paper No. 36

43 Pages Posted: 21 Mar 2012 Last revised: 25 Oct 2016

Florian Hett

Goethe University Frankfurt - Department of Management and Applied Microeconomics

Alexander Schmidt

Deutsche Bundesbank

Date Written: October 24, 2016

Abstract

We design a novel test for changes in market discipline based on the relation between firm-specific risk, credit spreads, and equity returns. We use our method to analyze the evolution of bailout expectations during the recent financial crisis. We find that bailout expectations peaked in reaction to government interventions following the failure of Lehman Brothers, and returned to pre-crisis levels following the initiation of the Dodd-Frank Act. We do not find such changes in market discipline for non-financial firms. Finally, market discipline is weaker for government-sponsored enterprises (GSEs) and systemically important banks (SIBs) than for investment banks.

Keywords: bailout, implicit guarantees, too-big-to-fail, market discipline, hedge ratio

JEL Classification: G14, G21, G28, H81

Suggested Citation

Hett, Florian and Schmidt, Alexander, Bank Rescues and Bailout Expectations: The Erosion of Market Discipline During the Financial Crisis (October 24, 2016). SAFE Working Paper No. 36. Available at SSRN: https://ssrn.com/abstract=2018830 or http://dx.doi.org/10.2139/ssrn.2018830

Florian Hett

Goethe University Frankfurt - Department of Management and Applied Microeconomics ( email )

Germany

Alexander Schmidt (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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