Lehman Brothers: What Did Markets Know?

74 Pages Posted: 2 Jun 2014

See all articles by Thomas Gehrig

Thomas Gehrig

University of Vienna - Faculty of Business, Economics, and Statistics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Vienna Graduate School of Finance (VGSF); Systemic Risk Centre - LSE

Marlene Haas


Date Written: March 2014


On September 15, 2008, Lehman Brothers Inc. announced their filing for bankruptcy. The reaction of Lehman's competitors and market participants to this bankruptcy filing announcement provides a unique field experiment of how the insolvency spills over to other financial institutions and how interconnectedness might trigger a financial crisis. Specifically, we analyze transaction prices of major U.S. investment and commercial banks prior to and after the bankruptcy. By decomposing their equity bid-ask spreads, we find evidence that the bankruptcy contributed to increasing adverse selection risk as well as inventory holding risk. Moreover, we find supporting evidence that the degree of competition among market makers did decline. All three components did contribute to a significant rise in transaction costs. Interestingly, the relative contribution of each channel has remained roughly constant. Finally, there is little evidence about insider information within the banking industry just prior to the bankruptcy. In the case of Lehman's stocks the adverse selection component rises in the last days of trading prior to the bankruptcy filing announcement. Moreover, we find no evidence of an increase in the adverse selection component of potential bidders, from which we interpret that the market did not expect a take-over or merger. We explore the robustness of our decomposition by employing volume-synchronized probability of informed trading-measures and impact regressions on prices, quantities, and their respective innovations. In general, we find that information effects are rather short-lived except for the three days prior to the Lehman insolvency.

Keywords: adverse selection costs, bid ask spreads, contagion, systemic risk

JEL Classification: D53, G12, G14

Suggested Citation

Gehrig, Thomas and Haas, Marlene, Lehman Brothers: What Did Markets Know? (March 2014). CEPR Discussion Paper No. DP9893. Available at SSRN: https://ssrn.com/abstract=2444914

Thomas Gehrig (Contact Author)

University of Vienna - Faculty of Business, Economics, and Statistics ( email )

Vienna, A-1210

Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020

Systemic Risk Centre - LSE ( email )

Houghton St, London WC2A 2AE, United Kingdom

Marlene Haas


No Address Available
United States

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