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Investor ambiguity, systemic banking risk and economic activity: The case of too-big-to-fail

Driouchi, Tarik; So, Raymond H.Y.; Trigeorgis, Lenos


Tarik Driouchi

Raymond H.Y. So


This paper examines the relationship between investors' ambiguity in the financial options market and systemic banks' risk. Eliciting ambiguity information from option pricing data on the twelve major U.S. banks between 2003 and 2010, we show that higher behavioral deviations from risk-neutral and Bayesian valuation (i.e., investor ambiguity) are associated with higher systemic banks' downside, market and credit risks. Consistent with behavioral explanations, we confirm the detrimental effect of ambiguity on financial market outcomes and find strong evidence of ambiguity among call and put option holders. Variance decomposition indicates that such a pattern of behavior explains a significant proportion of U.S. banking risk variance. This effect is more pronounced during periods of economic turbulence and bank stress (i.e., the 2007–2009 crisis), and holds after controlling for size, tail risk, implied volatility, and volatility of volatility dynamics. We also document that ambiguity from the financial market has a depressing impact on real economic activity, including capacity utilization, non-farm payrolls and overall economic performance. Our findings are robust to alternative specifications of ambiguity such as multiple priors and expected utilities with uncertain probabilities.


Driouchi, T., So, R. H., & Trigeorgis, L. (2020). Investor ambiguity, systemic banking risk and economic activity: The case of too-big-to-fail. Journal of Corporate Finance, 62, Article 101549.

Journal Article Type Article
Acceptance Date Dec 4, 2019
Online Publication Date Dec 12, 2019
Publication Date 2020-06
Deposit Date Feb 14, 2023
Journal Journal of Corporate Finance
Print ISSN 0929-1199
Publisher Elsevier
Volume 62
Article Number 101549
Public URL