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Equity is Cheap for Large Financial Institutions: The International Evidence

Priyank Gandhi, Hanno N. Lustig and Alberto Plazzi
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Hanno N. Lustig: Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

No 16-22, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Equity is a cheap source of funding for a country's largest financial institutions. In a large panel of 31 countries, we find that the stocks of a country's largest financial companies earn returns that are significantly lower than stocks of non-financials with the same risk exposures. In developed countries, only the largest banks' stock earns negative risk-adjusted returns, but, in emerging market countries, other large non-bank financial firms do. Even though large banks have high betas, these risk-adjusted return spreads cannot be attributed to the risk anomaly. Instead, we find that the large-minus-small, financial-minus-nonfinancial, risk-adjusted spread varies across countries and over time in ways that are consistent with stock investors pricing in the implicit government guarantees that protect shareholders of the largest banks. The spread is significantly larger for the largest banks in countries with deposit insurance, backed by fiscally strong governments, and in common law countries that offer shareholders better protection from expropriation. Finally, the spread also predicts large crashes in that country's stock market and output.

Keywords: Banking crisis; Banking; Government bailouts (search for similar items in EconPapers)
JEL-codes: G01 G12 G21 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2016-03, Revised 2016-06
New Economics Papers: this item is included in nep-ban and nep-ifn
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Citations: View citations in EconPapers (9)

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Working Paper: Equity Is Cheap for Large Financial Institutions: The International Evidence (2016) Downloads
Working Paper: Equity is Cheap for Large Financial Institutions: The International Evidence (2016) Downloads
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