American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Too-Systemic-to-Fail: What Option Markets Imply about Sector-Wide Government Guarantees
American Economic Review
vol. 106,
no. 6, June 2016
(pp. 1278–1319)
(Complimentary)
Abstract
We examine the pricing of financial crash insurance during the 2007-2009 financial crisis in US option markets, and we show that a large amount of aggregate tail risk is missing from the cost of financial sector crash insurance during the crisis. The difference in costs between out-of-the-money put options for individual banks and puts on the financial sector index increases four-fold from its precrisis 2003-2007 level. We provide evidence that a collective government guarantee for the financial sector lowers index put prices far more than those of individual banks and explains the increase in the basket-index put spread.Citation
Kelly, Bryan, Hanno Lustig, and Stijn Van Nieuwerburgh. 2016. "Too-Systemic-to-Fail: What Option Markets Imply about Sector-Wide Government Guarantees." American Economic Review, 106 (6): 1278–1319. DOI: 10.1257/aer.20120389Additional Materials
JEL Classification
- E44 Financial Markets and the Macroeconomy
- G01 Financial Crises
- G13 Contingent Pricing; Futures Pricing; option pricing
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- G28 Financial Institutions and Services: Government Policy and Regulation
- H81 Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts