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

Neumann, Michael, Financial Sector Tail Risk and Real Economic Activity: Evidence from the Option Market (September 15, 2014). Available at SSRN: https://ssrn.com/abstract=2504445 or http://dx.doi.org/10.2139/ssrn.2504445

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