Financial Firm Bankruptcy and Contagion*

Abstract

The Lehman bankruptcy highlights the potential for interconnectedness to cause negative externalities through counterparty contagion, but the externalities may also arise from information contagion. We examine contagion from troubled financial firms and find that counterparty contagion is greater during recessions and in cases of riskier firms and larger and more complex exposures. However, the counterparty exposures are small, especially among banks that face diversification regulations, and do not typically cause a cascade of failures.Information contagion is stronger for rivals in the same locale or the same line of business and is stronger in cases of distress than in bankruptcies.

Financial firm bankruptcies, international stock markets, and investor sentiment

“…With an aggregate value of assets exceeding 600 billion USD at the time of the announcement, the Lehman Brothers bankruptcy was the largest in history and is associated with the onset of the global financial crisis in 2008. That set aside, there are also other adverse effects related to financial firm bankruptcies such as contagion effects in the stock prices of competitors (Aharony & Swary, 1996;Gay, Timme, & Yung, 1991;Helwege & Zhang, 2016;Yamori, 1999) and the stock prices of firms with exposure in the failing financial institutions (Chakrabarty & Zhang, 2012;Fernando, May, & Meggison, 2012). Overall, there is evidence to support the view that stock prices of corporations related to financial firms filing for bankruptcy decline following the announcement.…”

Does Interindustry and Intraindustry Information Help Predict Financial Distress?

“…Interindustry information along the supply chain is also relevant when assessing financial distress. Jorion and Zhang (2009), and Helwege and Zhang (2015) also examine the contagion effect of distress on the firm's rivals, suppliers, and customers. Hertzel et al (2008) and Kolay et al (2016) find that suppliers' stock prices experience significantly negative impacts when a customer files for bankruptcy.…”

Model specification and collateralized debt obligation (mis)pricing

“…In addition to the frailty factor, recent literature documents the important role of contagion in explaining the default clustering. Helwege and Zhang (2016) investigate the counterparty contagion and information contagion for financial firms. Azizpour et al (2018) find that contagion and firms exposure to observable and latent systematic factors explain significant part of clustering.…”