Too-Systemic-to-Fail: What Option Markets Imply about Sector-Wide Government Guarantees
Bryan Kelly, Hanno Lustig, Stijn Van Nieuwerburgh
American Economic Review · 2016 · Volume 106 · Issue 6
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.
Keywords
Financial Markets and the Macroeconomy, Financial Crises, Contingent Pricing, Futures Pricing, option pricing, Banks, Depository Institutions, Micro Finance Institutions, Mortgages, Financial Institutions and Services: Government Policy and Regulation, Governmental Loans, Loan Guarantees, Credits, Grants, Bailouts
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