Abstract
We examine institutions’ revealed preferences towards default risk in publicly traded savings and loan institutions (S&Ls or thrifts). We test whether institutions consider default risks to be fairly priced, and therefore do not mind holding thrifts exposed to it. Our tests avoid the problems associated with measuring risks and returns ex-ante versus ex-post. An important underlying assumption of the distress anomaly is that financially distressed firms tend to cluster, preventing investors from diversifying away their risks. During the two financial crises, thrifts clearly met this criteria. We find statistically significant evidence for an inverse relationship between institutional ownership and thrift default risk. We also find statistically significant evidence that institutions increase ownership during financial crises. Our results hold for fixed effects and three stage least squares (3SLS) regressions as robustness tests to deal with missing variable bias and endogeneity between default risk and institutional ownership.
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