TARP and Market Discipline: Evidence on the Moral Hazard Effects of Bank Recapitalizations

52 Pages Posted: 16 Oct 2015

See all articles by Jens Forssbæck

Jens Forssbæck

Lund University - Department of Economics

Caren Yinxia Nielsen

Copenhagen Business School - Center for Corporate Governance; Knut Wicksell Centre for Financial Studies--Lund University

Date Written: October 9, 2015

Abstract

We examine the moral hazard effects of bank recapitalizations by assessing the impact of the U.S. TARP program on market discipline exerted by subordinated debt-holders using a sample of 123 bank holding companies over the period 2004-2013. Predicted distress risk has a consistently positive and significant effect on sub-debt spreads, suggesting the presence of market discipline. A higher bailout probability significantly reduces the risk-sensitivity of spreads for the full sample, indicating a moral hazard effect of recapitalizations. This appears to be a too-big-to-fail effect, as it is absent when the largest banks are dropped from the sample. Results also indicate that it is transitory. We also find a large effect of the crisis, appearing both as a uniform rise in, and a heightened risk sensitivity of, sub-debt spreads during the crisis.

Keywords: bank bailouts, moral hazard, distress risk, capital injections, TARP, CPP, market discipline, nancial crisis

JEL Classification: E50, G01, G21, G28, H12

Suggested Citation

Forssbaeck, Jens and Nielsen, Caren Yinxia, TARP and Market Discipline: Evidence on the Moral Hazard Effects of Bank Recapitalizations (October 9, 2015). Available at SSRN: https://ssrn.com/abstract=2674544 or http://dx.doi.org/10.2139/ssrn.2674544

Jens Forssbaeck (Contact Author)

Lund University - Department of Economics ( email )

P.O. Box 7082
S-220 07 Lund
Sweden

Caren Yinxia Nielsen

Copenhagen Business School - Center for Corporate Governance ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+4538152694 (Phone)

HOME PAGE: http://https://sites.google.com/site/carensprofhome/

Knut Wicksell Centre for Financial Studies--Lund University ( email )

Box 7082
Lund, S220 07
Sweden

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