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Bank Bailouts and Market Discipline: How Bailout Expectations Changed During the Financial Crisis

  • Florian Hett

    ()

    (Department of Economics, Johannes Gutenberg-Universitaet Mainz, Germany)

  • Alexander Schmidt

    ()

    (Goethe University Frankfurt and GSEFM, Germany)

We show that market discipline, defined as the extent to which frm specific risk characteristics are reflected in market prices, eroded during the recent financial crisis in 2008. We design a novel test of changes in market discipline based on the relation between firm specific risk characteristics and debt-to-equity hedge ratios. We find that market discipline already weakened after the rescue of Bear Stearns before disappear- ing almost entirely after the failure of Lehman Brothers. The effect is stronger for investment banks and large financial institutions, while there is no comparable effect for non-financial firms.

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File URL: http://www.macro.economics.uni-mainz.de/RePEc/pdf/Discussion_Paper_1305.pdf
File Function: First version, 2013
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Paper provided by Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz in its series Working Papers with number 1305.

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Length: 42 pages
Date of creation: 01 Aug 2013
Date of revision: 01 Aug 2013
Handle: RePEc:jgu:wpaper:1305
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