Abstract

http://ssrn.com/abstract=2024416
 
 

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Demand for Crash Insurance, Intermediary Constraints, and Stock Return Predictability


Hui Chen


Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)

Scott Joslin


University of Southern California

Sophie X. Ni


Hong Kong University of Science and Technology

March 31, 2014

AFA 2013 San Diego Meetings Paper

Abstract:     
The net amount of deep out-of-the-money (DOTM) S&P 500 put options that public investors purchase (or equivalently, the amount that financial intermediaries sell) in a month is a strong predictor of future market excess returns. A one-standard deviation decrease in our public net buying-to-open measure (PNBO) is associated with a 3.4% increase in the subsequent 3-month market excess return. The predictive power of PNBO is especially strong during the 2008-09 financial crisis, and it cannot be accounted for by a wide range of standard return predictors. Moreover, periods of low PNBO are associated with steeper slopes of the implied volatility curves and slower growth in broker-dealer leverages. To explain these findings, we build a general equilibrium model of the crash insurance market, where time variation in intermediaries' constraints help generate the dynamic relationships between equilibrium public demand for crash insurance, intermediary leverage, and the market risk premium. Our results suggest that the way financial intermediaries manage their tail risk exposures provides unique information about intermediary constraints.

Number of Pages in PDF File: 47

Keywords: Intermediary constraint, tail risk, SPX options, return predictability, liquidity

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Date posted: March 19, 2012 ; Last revised: April 7, 2014

Suggested Citation

Chen, Hui and Joslin, Scott and Ni, Sophie X., Demand for Crash Insurance, Intermediary Constraints, and Stock Return Predictability (March 31, 2014). AFA 2013 San Diego Meetings Paper. Available at SSRN: http://ssrn.com/abstract=2024416 or http://dx.doi.org/10.2139/ssrn.2024416

Contact Information

Hui Chen
Massachusetts Institute of Technology ( email )
50 Memorial Drive
Cambridge, MA 02142
United States
617-324-3896 (Phone)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Scott Joslin (Contact Author)
University of Southern California ( email )
Marshall School of Business
Los Angeles, CA 90089
United States
Sophie Xiaoyan Ni
Hong Kong University of Science and Technology ( email )
Clearwater Bay
Kowloon
Hong Kong
852-2358 5052 (Phone)
HOME PAGE: http://sophiexni.googlepages.com
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