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The Price of Being a Systemically Important Financial Institution (SIFI)

The Price of Being a Systemically Important Financial Institution (SIFI) After reviewing the notion of Systemically Important Financial Institution, we propose a first principles way to compute the price of the implicit put option that the State gives to such an institution. Our method is based on important results from extreme value theory, one for the aggregation of heavy‐tailed distributions and the other one for the tail behavior of the value at risk versus the tail value at risk. We show that the value of the put option is proportional to the value at risk of the institution and thus would provide the wrong incentive to banks who are qualified as Systemically Important Financial Institutions. This wrong incentive exists even if the guarantee is not explicitly granted. We conclude with a proposal to make the institution pay the price of this option to a fund, whose task would be to guarantee the orderly bankruptcy of such an institution. This fund would function like an insurance selling a cover to clients. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Review of Finance Wiley

The Price of Being a Systemically Important Financial Institution (SIFI)

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References (6)

Publisher
Wiley
Copyright
© 2017 International Review of Finance Ltd. 2017
ISSN
1369-412X
eISSN
1468-2443
DOI
10.1111/irfi.12115
Publisher site
See Article on Publisher Site

Abstract

After reviewing the notion of Systemically Important Financial Institution, we propose a first principles way to compute the price of the implicit put option that the State gives to such an institution. Our method is based on important results from extreme value theory, one for the aggregation of heavy‐tailed distributions and the other one for the tail behavior of the value at risk versus the tail value at risk. We show that the value of the put option is proportional to the value at risk of the institution and thus would provide the wrong incentive to banks who are qualified as Systemically Important Financial Institutions. This wrong incentive exists even if the guarantee is not explicitly granted. We conclude with a proposal to make the institution pay the price of this option to a fund, whose task would be to guarantee the orderly bankruptcy of such an institution. This fund would function like an insurance selling a cover to clients.

Journal

International Review of FinanceWiley

Published: Jan 1, 2017

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