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Too-big-to-fail: The value of government guarantee

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  • Tsafack, Georges
  • Li, Yifei
  • Beliaeva, Natalia

Abstract

Following the 2008 financial crisis and the government bailout of troubled companies, Too-Big-to-Fail became a standard expression to name a free protection of Wall Street by tax-payers' money. What should have been the fair cost of this protection? We offer a novel approach to estimate the value of the implicit government guarantee by combining the contingent claim pricing with the likelihood of the government intervention. We find that the cost of this implicit protection can go beyond tens of billions of dollars with an average of about $13 million per company, per year, and it rises to about $24 million if the government is assumed to intervene with certainty. Moreover, we show that the spread of the funding costs of the large banks over the small banks is strongly inversely associated with the value of the implicit government guarantee, especially after the crisis. For the Chinese companies, we use the contingent claims approach to measure the government guarantee and find that the value of the guarantee for State-owned Enterprises (SOEs) is inversely related to their bond yield spreads.

Suggested Citation

  • Tsafack, Georges & Li, Yifei & Beliaeva, Natalia, 2021. "Too-big-to-fail: The value of government guarantee," Pacific-Basin Finance Journal, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:pacfin:v:68:y:2021:i:c:s0927538x19305116
    DOI: 10.1016/j.pacfin.2020.101313
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    Cited by:

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    2. Liu, Tianming & Xiong, Haifang & Li, Yifei & Wang, Zhiqiang, 2023. "The flight to safety during credit recovery: The role of implicit government guarantees," Pacific-Basin Finance Journal, Elsevier, vol. 79(C).
    3. Gupta, Juhi & Kashiramka, Smita & Ly, Kim Cuong & Pham, Ha, 2023. "The interrelationship between bank capital and liquidity creation: A non-linear perspective from the Asia-Pacific region," International Review of Economics & Finance, Elsevier, vol. 85(C), pages 793-820.

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    More about this item

    Keywords

    Too-big-to-fail; Implicit guarantee; Contingent claim; Funding cost; Chinese SOEs;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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