Working Paper: NBER ID: w22355
Authors: Priyank Gandhi; Hanno Lustig; Alberto Plazzi
Abstract: In most countries, equity is a cheap source of funding for a country’s largest financial institutions. On average, the stocks of the top 10% financial companies in a country account for over a quarter of total market capitalization, but these stocks earn returns that are significantly lower than stocks of non-financial firms of the same size and with the same risk exposures. In a bailout-augmented asset pricing model with rare disasters, country characteristics that inform the likelihood of a bailout should predict stock returns. We find greater financial pricing anomalies for the largest banks in developed countries with a highly concentrated and large banking sector and fiscally strong governments, but smaller anomalies in countries with strong corporate governance, government integrity, and property rights as well as high bankruptcy costs. The pricing discrepancy widens in anticipation of large stock market and GDP declines, as the bailout-augmented asset pricing model would predict.
Keywords: equity; financial institutions; government guarantees; cost of capital
JEL Codes: G12; G18; G2; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| implicit government guarantees (H81) | lower cost of equity capital for large financial institutions (G21) |
| country characteristics (O57) | impact of implicit government guarantees on financial stock returns (G32) |
| expected market downturns (G17) | performance of large banks (G21) |
| implicit government guarantees (H81) | performance of large financial firms during economic crises (G01) |
| size of financial institutions (G21) | risk-adjusted returns (G12) |
| risk-adjusted returns of large financial firms (G32) | likelihood of financial crises (G01) |