While government led bank capital infusions in US and other developed markets have been usually contingent an external shock or crisis episode, India presents a unique setting where significant capital infusions happen annually to stabilize the weak balance sheets of undercapitalized government owned public sector banks. Such “repeated” capital infusions can either better engender financial stability, given the timely government interventions; or create instability arising from possible moral hazard concerns. "Do such repeated government capital infusions lower banks’ financial risks and improve financial stability?” We shed light on the question through the lens of capital infusions in the Indian market. Based on the exhaustive sample of government capital infusions into public sector banks for the period 2008–18, we find robust evidence that capital infusions are associated with economically significant higher default, capital shortfall and network risks post-infusion, signaling a moral hazard problem, where treated banks may assume more risky investments.

Motivated by the theory of demand-based option pricing in imperfect markets, we examine the relation between short-sale constraints and equity option returns, conditional on the level of mispricing in the underlying stock. We report a monotonic relation between various measures of short-sale constraints and delta-hedged returns of put options on overpriced stocks. This relation is robust to controls for firm attributes and limits to arbitrage proxies. Our findings suggest that while investors drive up the demand for these put options, dealers command a high premium as compensation for the increased market making risk. We do not find a robust relation for either put options on underpriced stocks or call options.