U.S. Bank Stocks and the Subprime Crisis

Table of Contents

1. Introduction

2. The Subprime Crisis

2.1. The Risk Types Involved

2.2. The Role of the Players

2.2.1. Rating Agencies

2.2.2. Mortgage Brokers and Lenders

2.2.3. Special Investment Vehicles

2.2.4. Central Banks

2.2.5. Financial Institutions

2.3. Impact on Earnings and Stock Prices

2.4. The Bailouts

2.4.1. Bear Stearns

2.4.2. Fannie Mae and Freddie Mac

2.4.3. Lehman Brothers Holdings Inc.

2.4.4. American International Group

2.4.5. Washington Mutual

2.5. The Broadening of the Crisis

3. The Design of an Event Study

3.1. Basics

3.2. History of Event Studies

3.3. Experimental Design

3.4. Use of Daily Data

3.4.1. Returns

3.4.2. Non-normality

3.4.3. Simple Linear Regression

3.4.4. Variance Estimation

3.4.5. Non-synchronous Trading

3.4.6. Clustering

3.5. Abnormal Returns

3.5.1. Mean Adjusted Return Model

3.5.2. Market Adjusted Return Model

3.5.3. Capital Asset Pricing Model

3.5.4. OLS Market Model

3.5.5. Scholes – Williams Procedure

3.5.6. Dimson Aggregated Coefficients Method

3.5.7. Cumulative Abnormal Returns

3.6. Significance of Abnormal Returns

3.6.1. Parametric Tests

3.6.1.1. Cross-sectional Independence

3.6.1.2. Cross-sectional Dependence (Crude Adjustment)

3.6.1.3. Standardized Tests

3.6.2. Non-parametric Tests

3.6.2.1. The Rank Test

3.6.2.2. The Sign Test

4. Results of the Event Study

4.1. Estimated Abnormal Returns

4.1.1. Release of the Third Quarter 2007 Earnings

4.1.2. Release of the Fourth Quarter 2007 Earnings

4.1.3. Release of the First Quarter 2008 Earnings

4.1.4. Release of the Second Quarter 2008 Earnings

4.2. Diagnostics

4.2.1. Test for Normality of Arithmetic Returns

4.2.2. Test for Normality of Abnormal Returns

4.2.3. Autocorrelation of the Stocks

4.3. Results of Significance Tests of Abnormal Returns

4.3.1. Significance, Event of Third Quarter 2007 Earnings Releases

4.3.2. Significance, Event of Fourth Quarter 2007 Earnings Releases

4.3.3. Significance, Event of First Quarter 2008 Earnings Releases

4.3.4. Significance, Event of Second Quarter 2008 Earnings Releases

5. Summary

6. Literature

Research Objectives and Key Topics

This thesis investigates whether abnormal stock returns of major U.S. banks, triggered by ad-hoc write-off announcements during the subprime crisis, are measurable and statistically significant. The research seeks to quantify investor reactions to quarterly earnings reports from Q3 2007 to Q2 2008 in relation to the S&P 500 index.

• The evolution and mechanics of the 2007/08 subprime mortgage crisis.
• Evaluation of banking sector stability and the role of systemic players like rating agencies and central banks.
• Methodological application of event study models (Market Adjusted Returns and OLS Market Model).
• Statistical validation of abnormal returns using parametric and non-parametric testing frameworks.

Excerpt from the Book

Chapter Summaries

1. Introduction: Presents the background of the 2008/09 financial crisis and defines the research question regarding abnormal bank stock returns.

2. The Subprime Crisis: Details the history, risk factors, and key institutional players of the crisis, culminating in major bank failures and bailouts.

3. The Design of an Event Study: Outlines the methodological framework, including data treatment, return models, and statistical tests for significance.

4. Results of the Event Study: Analyzes the calculated abnormal returns for four earnings release periods and interprets the statistical significance of these results.

5. Summary: Concludes the thesis by synthesizing the research findings and discussing the broader implications of the crisis for future financial regulation.

6. Literature: Lists the cited academic papers, news reports, and institutional data sources used throughout the analysis.

Keywords

Subprime Crisis, Event Study, Abnormal Returns, Market Adjusted Return Model, OLS Market Model, U.S. Banking Sector, Stock Performance, Earnings Announcements, Write-offs, Financial Stability, Mortgage Backed Securities, Bailouts, Statistical Significance, Parametric Tests, Non-parametric Tests

Frequently Asked Questions

What is the core focus of this research?

The research focuses on the impact of ad-hoc write-off announcements during the subprime crisis on the stock price performance of leading U.S. banks.

What are the primary themes addressed?

Central themes include the origins of the subprime crisis, the failure of risk management in financial institutions, the mechanics of market bailouts, and the quantitative analysis of stock market reactions using event study methodology.

What is the main objective or research question?

The research asks whether the abnormal stock returns associated with the announced write-offs of the analyzed U.S. banks are measurable and statistically significant.

Which scientific method is applied?

The thesis utilizes event study methodology, comparing observed security returns against a benchmark (S&P 500) using both the Market Adjusted Return Model and the Ordinary Least Squares (OLS) Market Model.

What topics are discussed in the main body?

The main body covers the historical context of the subprime mortgage crisis, the methodologies for designing an event study with daily data, and the specific results of significance tests for four distinct quarterly earnings announcement periods.

How is the paper characterized by its keywords?

The work is characterized by terms related to financial crises, econometric event studies, and specific financial instruments such as Mortgage Backed Securities (MBS) and Collateralized Debt Obligations (CDO).

How does the subprime crisis affect the non-normality of data?

The crisis introduced high volatility and extreme events, leading to "heavy tails" in return distributions, which necessitates careful handling of standard statistical tests due to leptokurtic distribution.

What was the outcome for Bear Stearns during the crisis?

Bear Stearns faced near collapse due to its exposure to subprime derivatives and was eventually acquired by JP Morgan Chase & Co. in a government-backed deal.

Why are non-parametric tests employed in the study?

They are used to ensure the robustness of conclusions, as the underlying return data frequently violate the assumptions of normality required by standard parametric tests.

How did investors respond to earnings reports during the study period?

Interestingly, despite expectations of bad earnings, the study suggests that in a bear market, buying stocks shortly before or around earnings announcements could lead to positive abnormal returns.