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Conjectural guarantees loom large: evidence from the stock returns of Fannie Mae and Freddie Mac

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  • Frank A. Schmid

Abstract

Fannie Mae and Freddie Mac are government sponsored enterprises (GSEs) with publicly traded equity. Although these companies hold government issued charters, their securities are not legally backed by the full faith and credit of the United States government. Yet, investors and rating agencies seem to believe that the U.S. Government would \"bail out\" Fannie or Freddie if they became distressed. We provide evidence of a conjectural guarantee in GSE stock returns. Stock that contains an option on returning the shares at a given price to the issuer -- the government, in this case -- show pronounced nonlinearity (convexity) in the sensitivity of its return to market return. Using non parametric methods on daily stock returns, we find that the GSEs' returns are less responsive to market movements the more sharply the market declines. Our findings are consistent with a government guarantee in GSE stock against catastrophic losses but not against atrophic losses.

Suggested Citation

  • Frank A. Schmid, 2003. "Conjectural guarantees loom large: evidence from the stock returns of Fannie Mae and Freddie Mac," Working Papers 2003-031, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2003-031
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    References listed on IDEAS

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    Cited by:

    1. Xiaoli Wang & Michael S. Long & Ren Raw Chen & Jingfeng Zhang, 2016. "Economic growth potential creating a real put and the resulting valuation of the firm," Review of Quantitative Finance and Accounting, Springer, vol. 47(3), pages 453-474, October.

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