Posted by Priyank Gandhi, Mendoza College of Business, University of Notre Dame, on Tuesday, July 19, 2016
Editor's Note: Priyank Gandhi is Assistant Professor at the University of Notre Dame’s Mendoza College of Business. This post is based on a recent paper authored by Professor Gandhi; Hanno N. Lustig, Professor of Finance at Stanford Graduate School of Business; and Alberto Plazzi, Assistant Professor of Finance at USI Lugano.
In countries around the world, governments and regulators are commonly perceived by market participants to offer special protections to the depositors, bondholders, and other creditors of large financial institutions in times of financial distress. A key question is whether these implicit and explicit government guarantees—collectively referred to as “Too Big to Fail (TBTF)”—also protect the shareholders of large financial institutions. In our paper, Equity is Cheap for Large Financial Institutions: The International Evidence, we set out to measure the effect of these implicit shareholder guarantees by closely examining the returns on stocks of large financial institutions.