Financial Sector Tail Risk and Real Economic Activity: Evidence from the Option Market
46 Pages Posted: 7 Oct 2014
Date Written: September 15, 2014
Abstract
This paper documents that option-implied tail risk in the U.S. financial sector predicts real economic activity. The predictability is found to be incremental to the information content in a stock price-based measure of financial sector tail risk. This finding holds both in- and out-of-sample and is not driven by the 2007 to 2009 sub-prime crisis. The predictability can instead be attributed to the option market's ability to anticipate a rising funding cost differential between small and large banks which has a detrimental effect on real economic activity. The results have implications for the real-time monitoring of financial sector tail risk.
Keywords: Predictability, Real Economic Activity, Option Markets, Systemic Risk, Financial Institutions
JEL Classification: G0, G2 G10, G13, G17, C53, E37
Suggested Citation: Suggested Citation