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Inter-industry contagion and the competitive effects of financial distress announcements: evidence from commercial banks and life insurance companies

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  • Elijah Brewer
  • William E. Jackson

Abstract

Contagion usually refers to the spillover of the effects of shocks from one or more firms to other firms. Most studies of contagion limit their analysis to how shock affect firms in the same industry, or "intra-industry" contagion. The purpose of this paper is to explore and document the likely magnitude of "inter-industry" contagion. In their comprehensive study of intra-industry contagion using many individual industries Lang and Stulz (1992) argue that if contagion is not simply an informational effect it will impose a social cost on our economic system. If this is true for intra-industry contagion, then the same argument must hold for inter-industry contagion as well. We focus on inter-industry contagion effects in this paper because the vast majority of the extant literature about contagion has neglected its important potential cost to shareholders. Most of the studies on contagion attempts to differentiate between a "pure" contagion effect and a signaling or information-based contagion effect. An example of a pure contagion effect would be the negative effects of a bank failure spilling over to other banks regardless of the cause of the bank failure. And, an example of a signaling contagion effect would be if a bank failure is caused by problems whose revelation is correlated across banks, and the correlated banks are impacted negatively. We conduct our investigation of contagion by examining three separate announcements involving adverse information about commercial real estate portfolios. The first announcement is by a large commercial bank (the Bank of New England), the second announcement consists of a series of events--from several large banking organizations and a regulatory agency (the Office of the Comptroller of the Currency), and the third announcement is by a large life insurance company (Travelers). There are two reasons we chose these particular events. First, the events seemed to be very unusual and very significant indicators of future (and present) financial distress. Second, the events shared a common theme of financial distress caused by problems with commercial real estate portfolios. We first establish that the commercial bank announcements negatively impact the equity values of life insurance companies (and vice versa). Next, we demonstrate that the bank regulatory agency announcement negatively impacts the equity values of life insurance companies as well as commercial banks. We then explicitly test if the shareholder wealth effects are linked to a set of specific firm characteristics. Consistent with previous contagion studies, our results provide strong evidence of "intra-industry" contagion related wealth effects. We also find that these contagion effects, to a significant degree, can be explained by firm specific variables. This implies that the intra-industry spillover effects associated with our three events are not of the totally "pure" contagion variety, but have an informational component as well. We also find very strong evidence of significant "inter-industry" contagion-based shareholder wealth effects. Again, these contagion-based wealth effects do not appear to be purely contagion-based. Wealth effects can also be explained by such factors as geographic proximity, asset composition, liability composition, leverage, size, and regulatory expectations.

Suggested Citation

  • Elijah Brewer & William E. Jackson, 2002. "Inter-industry contagion and the competitive effects of financial distress announcements: evidence from commercial banks and life insurance companies," Working Paper Series WP-02-23, Federal Reserve Bank of Chicago.
  • Handle: RePEc:fip:fedhwp:wp-02-23
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    Cited by:

    1. Marco Stringa & Allan Monks, 2007. "Inter-industry contagion between UK life insurers and UK banks: an event study," Bank of England working papers 325, Bank of England.
    2. Elyasiani, Elyas & Mansur, Iqbal & Pagano, Michael S., 2007. "Convergence and risk-return linkages across financial service firms," Journal of Banking & Finance, Elsevier, vol. 31(4), pages 1167-1190, April.
    3. Fedorova, Elena, 2011. "Transfer of financial risk in emerging eastern European stock markets : A sectoral perspective," BOFIT Discussion Papers 24/2011, Bank of Finland, Institute for Economies in Transition.
    4. Jiang Cheng & Elyas Elyasiani & Tzu-Ting Lin, 2010. "Market Reaction to Regulatory Action in the Insurance Industry: The Case of Contingent Commission," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(2), pages 347-368.
    5. TSURUTA Daisuke, 2007. "Credit Contagion and Trade Credit Supply: Evidence from Small Business Data in Japan," Discussion papers 07043, Research Institute of Economy, Trade and Industry (RIETI).
    6. G. Hauton & J.-C. Héam, 2014. "How to Measure Interconnectedness between Banks, Insurers and Financial Conglomerates?," Débats économiques et financiers 15, Banque de France.
    7. Elahi, M.A., 2011. "Essays on financial fragility," Other publications TiSEM 882f55bb-10dc-4e49-95ef-e, Tilburg University, School of Economics and Management.
    8. Sheremet, Oleg & Lucas, André, 2009. "Global loss diversification in the insurance sector," Insurance: Mathematics and Economics, Elsevier, vol. 44(3), pages 415-425, June.
    9. Terhi Jokipii & Brian Lucey, 2005. "CEE Banking Sector Co-Movement: Contagion or Interdependence?," The Institute for International Integration Studies Discussion Paper Series iiisdp077, IIIS.
    10. Gaël Hauton & Jean-Cyprien Héam, 2015. "Interconnectedness of Financial Conglomerates," Risks, MDPI, Open Access Journal, vol. 3(2), pages 1-25, May.

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    Keywords

    Insurance ; Bank failures ; Stocks;

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