Do Bond Investors Price Tail Risk Exposures of Financial Institutions?

44 Pages Posted: 30 Mar 2014 Last revised: 29 Mar 2021

See all articles by Sudheer Chava

Sudheer Chava

Georgia Institute of Technology - Scheller College of Business

Rohan Ganduri

Emory University

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: October 16, 2014

Abstract

We analyze whether bond investors price tail risk exposures of financial institutions using a comprehensive sample of bond issuances by U.S. financial institutions. Although primary bond yield spreads increase with an institutions' own tail risk (expected shortfall), systematic tail risk (marginal expected shortfall) of the institution doesn't affect its yields. The relationship between yield spreads and tail risk is significantly weaker for depository institutions, large institutions, government-sponsored entities, politically-connected institutions, and in periods following large-scale bailouts of financial institutions. Overall, our results suggest that implicit bailout guarantees of financial institutions can exacerbate moral hazard in bond markets and weaken market discipline.

Keywords: Financial Institutions, Moral Hazard, Market discipline, Implicit Guarantee, TBTF, Too-big-to-fail, Bailout, Tail risk

JEL Classification: G21, G22, G24, G28

Suggested Citation

Chava, Sudheer and Ganduri, Rohan and Yerramilli, Vijay, Do Bond Investors Price Tail Risk Exposures of Financial Institutions? (October 16, 2014). Quarterly Journal of Finance, Georgia Tech Scheller College of Business Research Paper No. 2417499, Available at SSRN: https://ssrn.com/abstract=2417499 or http://dx.doi.org/10.2139/ssrn.2417499

Sudheer Chava (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

HOME PAGE: http://https://fintech.gatech.edu

Rohan Ganduri

Emory University ( email )

1300 Clifton Rd
Atlanta, GA 30322
United States

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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