Essays in Stigma and Derivatives during a Financial Crisis

During the recent financial crisis, the Federal Reserve (Fed) was frustrated in its efforts to inject liquidity into the financial system. Central bankers at the Fed hypothesized that loans from the lender of last resort (LOLR) would lead market participants to infer weakness -- the so-called stigma problem. My dissertation examines to what extent banks are stigmatized after news is revealed that they received emergency loans from the LOLR. My dissertation also includes a chapter examining how the stock market viewed a nonfinancial firm's use of its interest rate derivative portfolio.;In Chapter 1, I examine the extent of the stigma problem. On August 22, 1932, the Clerk of the House of Representatives took it upon himself to publish the first of six lists of banks that had secretly borrowed from the LOLR during the Great Depression. Using a unique hand-collected dataset of balance sheet information for 2,674 banks, I compare the performance of those banks included on the initial list ("the treatment group" or "revealed banks") to banks not included on the list ("the control group" or "non-revealed banks"). I find results consistent with depositors interpreting news of a LOLR emergency loan as financial weakness; the deposits-to-assets ratio dropped by 5-7% at revealed banks compared to non-revealed banks Next, I ask how policy makers can use this information to alleviate the problem. I find evidence that when nearly all banks were publicly revealed to have borrowed in a defined banking market area, the effect of stigma disappeared. Therefore, designing emergency lending facilities that reveal information about nearly all banks simultaneously may be associated with less stigma.;In Chapter 2, I use the same empirical setting in Chapter 1 to examine how the stigma problem was affected by additional disclosures of bank lists. While the first disclosure on August 22, 1932 was unexpected and included the names of banks that had secretly borrowed from the LOLR, the subsequent disclosures included the names of banks that had borrowed knowing their identity would be revealed to the public. I find evidence that the public withdrew more from banks that were revealed on a subsequent disclosure relative to banks revealed on the first disclosure. However, the additional amount withdrawn was small. This result is consistent with the public interpreting the banks on a subsequent list as slightly financially weaker. These banks needed emergency funds so much that they were willing to risk revealing their identity but, ex-post, did not lose that much.;Finally, Chapter 3 examines if nonfinancial firms use interest rate (IR) derivatives to minimize cash flow volatility (consistent with "hedging") and/or reduce their cost of capital (consistent with "market timing"). Using a novel dataset of interest rate derivative information for 461 S&P 500 nonfinancial firms from 2002 to 2011, I find evidence that, on average, the size of the firm's interest rate derivative portfolio increased significantly by 53.04% during the recent financial crisis. Next, I use the announcement of Quantitative Easing (QE) on November 25, 2008, as a plausibly exogenous shock to interest rate movements to ex-post disentangle if firms were hedgers or market timers based on their cumulative abnormal returns. I find evidence that firms not using IR derivatives had significantly higher cumulative abnormal returns than firms using IR derivatives after QE. This suggests that the market did not interpret a firm's use of interest rate derivatives as a hedging tool to minimize cash flow volatility, but as a way for firms to take a view during uncertain macroeconomic times.