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Merge to be too big to fail: A real option approach

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  • Zhu, Jiaqing
  • Li, Guangzhong
  • Li, Jie

Abstract

We develop a real option model to analyze the timing of bank mergers motivated by the incentive to obtain too-big-to-fail (TBTF) status from the government. We show that mergers may occur even in the absence of scale economies, which is different from Lambrecht (2004). Moreover, the TBTF incentive lowers the threshold required for bank mergers, and the degree of scale diseconomies that the merging entities can tolerate increases as the probability of obtaining the TBTF status becomes higher. Our findings thus provide a theoretical explanation for the lack of scale economies in bank mergers identified in prior literature.

Suggested Citation

  • Zhu, Jiaqing & Li, Guangzhong & Li, Jie, 2017. "Merge to be too big to fail: A real option approach," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 342-353.
    • Handle: RePEc:eee:reveco:v:51:y:2017:i:c:p:342-353
    DOI: 10.1016/j.iref.2017.06.008
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    References listed on IDEAS

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    Cited by:

    1. Pereira, Paulo J. & Rodrigues, Artur, 2019. "Bargaining merger terms and the effect on the announcement returns," International Review of Economics & Finance, Elsevier, vol. 59(C), pages 510-521.

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    More about this item

    Keywords

    Merger; Too-big-to-fail; Real option; Economies of scale;
    All these keywords.

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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