Further Evidence on Equity Market Contagion: the FSLIC's Solvency and the Liquidity Crisis of Financial Corporation of America

Whether pure contagion is more likely to occur when a federal deposit insurer is severely undercapitalized is an unanswered question. This paper provides evidence on this issue by examining the stock market reaction of savings and loans (S&Ls) to the crisis of Financial Corporation of America (FCA) in 1984, when the Federal Savings and Loan Insurance Corporation was fiscally unsound. Consistent with a contingent insurance guarantee hypothesis, the results show large, significant negative abnormal returns (ARs) for a portfolio of high insured deposit S&Ls during FCA's crisis.