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Too-Systemic-To-Fail: What Option Markets Imply About Sector-wide Government Guarantees

  • Kelly, Bryan
  • Lustig, Hanno
  • van Nieuwerburgh, Stijn

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9023.

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Date of creation: Jun 2012
Date of revision:
Handle: RePEc:cpr:ceprdp:9023
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