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

Bryan Kelly | Zendy; Hanno Lustig | Zendy; Stijn Van Nieuwerburgh | Zendy

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

Author(s) -

Bryan Kelly,

Hanno Lustig,

Stijn Van Nieuwerburgh

Publication year - 2016

Publication title -

american economic review

Language(s) - English

Resource type - Journals

SCImago Journal Rank - 16.936

H-Index - 297

eISSN - 1944-7981

pISSN - 0002-8282

DOI - 10.1257/aer.20120389

Subject(s) - systemic risk , economics , crash , financial crisis , index (typography) , government (linguistics) , financial market , financial system , deposit insurance , financial sector , monetary economics , finance , business , macroeconomics , linguistics , philosophy , world wide web , computer science , programming language

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. (JEL E44, G01, G13, G21, G28, H81)

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