Size Anomalies in US Bank Stock Returns: Your Tax Dollars at Work?

Over the last four decades, the average Gaussian-risk-adjusted return on a stock portfolio that goes long in the largest banks and short in the smallest banks is minus 7 %. Moreover, this portfolio provides US investors with insurance against recessions, even though the cash flows of large banks seem more exposed to macroeconomic risk. Using the rare events model of ?, we interpret the 7% as a disaster risk premium. Recessions are periods with a high probability of a disaster. In a calibrated version of the model, we estimate an implicit recovery rate in disaster states that is 44 percentage points higher for the largest banks than for the smallest banks. If these large differences in the implied recovery rates indeed reflect the market’s expectations of the government’s asymmetric actions during a disaster, then the disaster risk discount for large banks represents a large hidden subsidy to large banks and a tax on small