Professor Bryan T. Kelly of Booth School of Business and co-authors (Prof. Hanno Lustig of UCLA and Stijn Van Nieuwerburg of New York University) undertake a field research to understand how government intervention and economic outcomes offer new insights into the effect of bailouts on the value of the banking sector.
Europe is wrestling with structuring a bailout as its financial firms and broader economies teeter on a precipice. In America, markets look to Europe with unease while politicians bicker over whether stimulus and backstops established in 2008 and 2009 caused the current economic malaise or if it might have been worse. On top of all of this, uncertainty about the ultimate outcomes of government intervention exacerbate the deeper underlying uncertainty responsible for much or the morass.
According to a research undertaken byme, Hanno Lustig (UCLA) and Stijn Van Nieuwerburgh (New York University), we seek to better understand the interplay of government intervention and economic outcomes by offering new insights into the effect of bailouts on the value of the banking sector. When the government guarantees the survival of financial institutions that are “too systemically risky to fail,” it is effectively providing free crash insurance to anyone who holds bank stocks. More specifically, it insures the banking sector as a whole, but does not necessarily insure individual banks (contrast the bailouts of Bank of America and AIG with the failures of Lehman and Bear Stearns).
This effect can indeed be seen very clearly in the cost of put options on the financial sector ETF and put options on individual banks stocks (put options are in essence crash insurance for stocks and stock indices). We examine the prices of these insurance contracts prior to and during the 2007-2009 crisis in the US financial sector. What we find is that the cost of traded crash insurance (put options) on the entire financial sector become puzzlingly cheap during the crisis, while the prices of puts on individual banks remained high. In effect, the government substantially subsidised the cost of index puts, which drove down the prices investors were willing to pay for the traded version of this insurance. Since any individual bank may still fail amid a guarantee, the effect was much weaker for individual bank puts. The puzzling divergence in the cost of single name puts relative to index puts during the crisis is well-explained by the bailout story after all.
According to a research undertaken byme, Hanno Lustig (UCLA) and Stijn Van Nieuwerburgh (New York University), we seek to better understand the interplay of government intervention and economic outcomes by offering new insights into the effect of bailouts on the value of the banking sector. When the government guarantees the survival of financial institutions that are “too systemically risky to fail,” it is effectively providing free crash insurance to anyone who holds bank stocks. More specifically, it insures the banking sector as a whole, but does not necessarily insure individual banks (contrast the bailouts of Bank of America and AIG with the failures of Lehman and Bear Stearns).
This effect can indeed be seen very clearly in the cost of put options on the financial sector ETF and put options on individual banks stocks (put options are in essence crash insurance for stocks and stock indices). We examine the prices of these insurance contracts prior to and during the 2007-2009 crisis in the US financial sector. What we find is that the cost of traded crash insurance (put options) on the entire financial sector become puzzlingly cheap during the crisis, while the prices of puts on individual banks remained high. In effect, the government substantially subsidised the cost of index puts, which drove down the prices investors were willing to pay for the traded version of this insurance. Since any individual bank may still fail amid a guarantee, the effect was much weaker for individual bank puts. The puzzling divergence in the cost of single name puts relative to index puts during the crisis is well-explained by the bailout story after all.
Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
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An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
For More IIPM Info, Visit below mentioned IIPM articles.
IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
IIPM's Management Consulting Arm-Planman Consulting
