What Can Volatility Smiles Tell Us About the Too Big to Fail Problem?

58 Pages Posted: 13 Jul 2021

See all articles by Phong T. H. Ngo

Phong T. H. Ngo

Australian National University (ANU)

Diego Puente-Moncayo

University of Technology Sydney (UTS)

Date Written: June 29, 2021

Abstract

We exploit the information content of option prices to construct a novel measure of bank tail-risk. We document a persistent increase in tail-risk for the U.S. banking industry following the global financial crisis, except for banks designated as systemically important by the Dodd-Frank Act. We show that this post-crisis difference in tail-risk for large and small banks is consistent with the too-big-to-fail (TBTF) status of large banks being reinforced by the Dodd-Frank designation: Naming the banks whose failure could threaten the financial stability of the U.S. gave investors a list of banks the government deemed as TBTF.

Keywords: too-big-to-fail, volatility smile, implicit guarantees, bank regulation

JEL Classification: G01, G20, G21, G28

Suggested Citation

Ngo, Phong T. H. and Puente Moncayo, Diego, What Can Volatility Smiles Tell Us About the Too Big to Fail Problem? (June 29, 2021). Available at SSRN: https://ssrn.com/abstract=3876320 or http://dx.doi.org/10.2139/ssrn.3876320

Phong T. H. Ngo (Contact Author)

Australian National University (ANU) ( email )

RSFAS, College of Business and Economics
Australian National University
Canberra, Australian Capital Territory 0200
Australia
+61 2 6125 1079 (Phone)

HOME PAGE: http://cbe.anu.edu.au/people/rsfas/phong-ngo/

Diego Puente Moncayo

University of Technology Sydney (UTS) ( email )

15 Broadway, Ultimo
PO Box 123
Sydney, NSW 2007
Australia

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