Tests of Global Flights to Safety with US Financial Firm Bankruptcy Announcements

Abstract

This paper investigates whether bankruptcy announcements by large US financial institutions can induce flights to safety, leading investors to seek safer investments. To test this relationship, we employ a short-horizon event study methodology and show that low-risk investments—such as the US dollar, sovereign bonds and gold—exhibit significant appreciation following such announcements. This result is more pronounced when the local country-level investor sentiment declines in the post-announcement period. We also analyze the transmission mechanism through which bankruptcy announcements cause flights to safety and empirically identify a global information contagion channel via negative shocks to the cash flows of stocks. Our results are robust to several additional tests. These include removing the most influential bankruptcies from the sample of events, using more sophisticated event-study methodologies, and conducting a placebo test with random dates.

Keywords: financial firms, bankruptcy announcements, low-risk investments, global information contagion, sentiment

JEL Classification: G14, G15, F31, G33