The extant literature suggests that one of the main causes of the recent financial crisis was the excessive use of short-term debt by banks. Using a large sample of banks, we find that increases in repurchase agreements (repos) were recognized by external capital markets to increase bank risk in the pre-crisis period. In the crisis, we find a negative relationship between repos and risk. We attribute this result to evidence suggesting that “good” banks were able to continue funding their repos, whereas “bad” banks had to significantly decrease their repo funding.

This paper examines the informational role of equity options trading around Federal Open Market Committee (FOMC) announcements. We find that information contained in option trades prior to FOMC rate change announcements, measured as implied volatility spread, predicts bank stock returns to a greater degree than does volatility spread prior to non-meeting days. We examine U.S. banks due to their interest rate sensitivity; however, we also show that return predictability around rate changes is reliably stronger in all firms, across all industries that are more interest rate sensitive. We find that return predictability is primarily driven by surprise changes in interest rates that occur during meetings with high degrees of information asymmetry. Finally, we document that volatility spread impounds information about FOMC meetings before that information is reflected in stock prices; this effect is significantly greater during surprise events, suggesting that the options market is an important source of informed trading.