Working Paper: CEPR ID: DP9893
Authors: Thomas Gehrig; Marlene Haas
Abstract: On September 15, 2008, Lehman Brothers Inc. announced their filing for bankruptcy. The reaction of Lehman's competitors and market participants to this bankruptcy filing announcement provides a unique field experiment of how the insolvency spills over to other financial institutions and how interconnectedness might trigger a financial crisis. Specifically, we analyze transaction prices of major U.S. investment and commercial banks prior to and after the bankruptcy. By decomposing their equity bid-ask spreads, we find evidence that the bankruptcy contributed to increasing adverse selection risk as well as inventory holding risk. Moreover, we find supporting evidence that the degree of competition among market makers did decline. All three components did contribute to a significant rise in transaction costs. Interestingly, the relative contribution of each channel has remained roughly constant. Finally, there is little evidence about insider information within the banking industry just prior to the bankruptcy. In the case of Lehman's stocks the adverse selection component rises in the last days of trading prior to the bankruptcy filing announcement. Moreover, we find no evidence of an increase in the adverse selection component of potential bidders, from which we interpret that the market did not expect a take-over or merger. We explore the robustness of our decomposition by employing volume-synchronized probability of informed trading-measures and impact regressions on prices, quantities, and their respective innovations. In general, we find that information effects are rather short-lived except for the three days prior to the Lehman insolvency.
Keywords: adverse selection; costs; bid-ask spreads; contagion; systemic risk
JEL Codes: D53; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lehman Brothers' bankruptcy (G33) | increasing adverse selection risk (D82) |
| Lehman Brothers' bankruptcy (G33) | increasing inventory holding risk (G31) |
| increasing adverse selection risk (D82) | significant rise in transaction costs for other banks (F65) |
| increasing inventory holding risk (G31) | significant rise in transaction costs for other banks (F65) |
| Lehman Brothers' bankruptcy (G33) | significant increase in transaction costs across the financial sector (F65) |
| increased adverse selection risk (D82) | heightened information risk (D80) |
| Lehman Brothers' bankruptcy (G33) | informational contagion and increased counterparty risk (F65) |