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

forthcoming in the Journal of Financial and Quantitative Analysis

62 Pages Posted: 13 Jul 2021 Last revised: 6 Sep 2022

See all articles by Phong T. H. Ngo

Phong T. H. Ngo

Australian National University (ANU)

Diego Puente-Moncayo

Australian National University (ANU)

Date Written: September 1, 2022

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? (September 1, 2022). forthcoming in the Journal of Financial and Quantitative Analysis, 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

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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