The Put Problem with Buying Toxic Assets

Wilson, Linus

doi:10.2139/ssrn.1343625

Download This Paper

Open PDF in Browser

Add Paper to My Library

The Put Problem with Buying Toxic Assets

Applied Financial Economics, Vol. 20, No. 1, 2010

14 Pages Posted: 15 Feb 2009 Last revised: 6 Jan 2010

See all articles by Linus Wilson

Linus Wilson

University of Louisiana at Lafayette - College of Business Administration

Date Written: April 24, 2009

Abstract

This paper uses the option pricing arguments of Merton (1974) to demonstrate that even solvent banks will be reluctant to sell volatile, toxic assets at market prices. Banks' shareholders have insolvency puts that give them limited liability in the event of default. The insolvency puts are more valuable when the banks' assets are more volatile. Shareholders in banks will require any buyer to pay for the lost volatility as well as the market price of the toxic assets. Thus, taxpayers must be ready to richly overpay if they want banks to voluntarily part with their toxic assets.

Keywords: FDICIA, mortgage securities, PPIP, Public Private Investment Partnership, receivership, resolution authority, TARP, too big to fail, toxic assets

JEL Classification: G01, G13, G21, G28, G32

Suggested Citation: Suggested Citation

Wilson, Linus, The Put Problem with Buying Toxic Assets (April 24, 2009). Applied Financial Economics, Vol. 20, No. 1, 2010, Available at SSRN: https://ssrn.com/abstract=1343625 or http://dx.doi.org/10.2139/ssrn.1343625