Working Paper: CEPR ID: DP9023
Authors: Bryan Kelly; Hanno Lustig; Stijn Van Nieuwerburgh
Abstract: We examine the pricing of financial crash insurance during the 2007-2009 financial crisis in U.S. option markets. A large amount of aggregate tail risk is missing from the price of financial sector crash insurance during the financial crisis. The difference in costs of out-of-the-money put options for individual banks, and puts on the financial sector index, increases fourfold from its pre-crisis 2003-2007 level. We provide evidence that a collective government guarantee for the financial sector, which lowers index put prices far more than those of individual banks, explains the divergence in the basket-index put spread.
Keywords: financial crisis; government bailout; option pricing models; systemic risk; too big to fail
JEL Codes: E44; E60; G12; G13; G18; G21; G28; H23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government guarantees (H81) | price of index puts (G13) |
| government guarantees (H81) | price of individual bank puts (G19) |
| price of index puts (G13) | price of individual bank puts (G19) |
| government guarantees (H81) | basket-index put spread (G13) |
| positive government announcements (E60) | basket-index put spread (G13) |
| government guarantees (H81) | perceived risk (D81) |
| government guarantees (H81) | tail risk (D81) |