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Equity Is Cheap for Large Financial Institutions

78 Pages Posted: 14 Mar 2016 Last revised: 22 Jul 2017

Priyank Gandhi

Mendoza College of Business, University of Notre Dame

Hanno N. Lustig

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

Alberto Plazzi

USI-Lugano; Swiss Finance Institute

Date Written: July 20, 2017

Abstract

In most countries, equity is a cheap source of funding for a country’s largest financial institutions. On average, the stocks of the top 10% financial companies in a country account for over a quarter of total market capitalization, but these stocks earn returns that are significantly lower than stocks of non-financial firms of the same size and with the same risk exposures. In a bailout-augmented asset pricing model with rare disasters, country characteristics that inform the likelihood of a bailout should predict stock returns. We find greater financial pricing anomalies for the largest banks in developed countries with a highly concentrated and large banking sector and fiscally strong governments, but smaller anomalies in countries with strong corporate governance, government integrity, and property rights as well as high bankruptcy costs. The pricing discrepancy widens in anticipation of large stock market and GDP declines, as the bailout-augmented asset pricing model would predict.

Keywords: Financial crisis, Financial firms, Banking, Government bailouts

JEL Classification: G01, G21, G12

Suggested Citation

Gandhi, Priyank and Lustig, Hanno N. and Plazzi, Alberto, Equity Is Cheap for Large Financial Institutions (July 20, 2017). Swiss Finance Institute Research Paper No. 16-22; Paris December 2016 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2747307 or http://dx.doi.org/10.2139/ssrn.2747307

Priyank Gandhi

Mendoza College of Business, University of Notre Dame ( email )

253 Mendoza College of Business
Notre Dame, IN 46656
United States
5746313450 (Phone)

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alberto Plazzi (Contact Author)

USI-Lugano ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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