Is size everything?

Abstract

We examine sources of systemic risk (threshold size, complexity, and interconnectedness) with factors constructed from equity returns of large financial firms, after accounting for standard risk factors. From the factor loadings and factor returns, we estimate the implicit government subsidy for each systemic risk measure, and find that, from 1963 to 2006, only our big-versus-huge threshold size factor, TSIZE, implies a positive implicit subsidy on average. Further, pre-2007 TSIZE-implied subsidies predict the Federal Reserve's liquidity facility loans and the Treasury's TARP loans during the crisis, both in the time series and the cross section. TSIZE-implied subsidies increase around the bailout of Continental Illinois in 1984 and the Gramm-Leach-Bliley Act of 1999, as well as around changes in Fitch Support Ratings indicating higher probability of government support. Since 2007, however, the relative share of TSIZE-implied subsidies falls, especially after Lehman's failure, whereas complexity and interconnectedness-implied subsidies are substantial, resulting in an almost sevenfold increase in total implicit subsidies. The results, which survive a variety of robustness checks, indicate that the market's perception of the sources of systemic risk changes over time.