TARP and market discipline: Evidence on the moral hazardeffects of bank recapitalizations

Jens Forssbæck and Caren Xinxia Nielsen
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Caren Xinxia Nielsen: Knut Wicksell Centre for Financial Studies, Lund University

No 2015/9, Knut Wicksell Working Paper Series from Lund University, Knut Wicksell Centre for Financial Studies

Abstract: We examine the moral hazard effects of bank recapitalizations by assessing the impact of the U.S. TARP program on market discipline exerted by subordinated debt-holders using a sample of 123 bank holding companies over the period 2004- 2013. Predicted distress risk has a consistently positive and significant effect on sub-debt spreads, suggesting the presence of market discipline. A higher bailout probability significantly reduces the risk-sensitivity of spreads for the full sample, indicating a moral hazard effect of recapitalizations. This appears to be a too-bigto-fail effect, as it is absent when the largest banks are dropped from the sample. Results indicate that it is transitory. We also find a large effect of the crisis, appearing both as a uniform rise in, and a heightened risk sensitivity of, sub-debt spreads during the crisis.

Keywords: Bank bailouts; moral hazard; distress risk; capital injections; TARP; CPP; market discipline; financial crisis (search for similar items in EconPapers)
JEL-codes: E50 G01 G21 G28 H12 (search for similar items in EconPapers)
Pages: 72 pages
Date: 2015-10-01
Note: Full text versions of the paper: http://www.lusem.lu.se/media/kwc/working-papers/2015/wp_2015_9_full.pdf
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Related works:
Working Paper: TARP and Market Discipline: Evidence on the Moral Hazard Effects of Bank Recapitalizations (2016)
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