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American Economic Review Vol. 106 No. 6 2016

Too-Systemic-to-Fail: What Option Markets Imply about Sector-Wide Government Guarantees

Bryan Kelly1; Hanno Lustig2; Stijn Van Nieuwerburgh3

1 University of Chicago Booth School of Business, 5807 S. Woodlawn Avenue, Chicago, IL 60637, and NBER (e-mail: ) · 2 Stanford Graduate School of Business, 655 Knight Way, Stanford, CA 94305 (e-mail: ) · 3 New York University Stern School of Business, 44 West Fourth Street, New York, NY 10012, NBER, and CEPR (e-mail: )

open access

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.

DOI
10.1257/aer.20120389
Volume
106
Issue
6
Pages
1278-1319
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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