Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets
Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)
University of Southern California
Sophie X. Ni
Hong Kong University of Science and Technology
January 19, 2016
AFA 2013 San Diego Meetings Paper
We propose a new measure of financial intermediary constraints based on how the intermediaries manage their tail risk exposures. Using a unique dataset for the trading activities in the market of deep out-of-the-money S&P 500 put options, we identify periods when the variations in the net amount of trading between financial intermediaries and public investors are likely to be mainly driven by shocks to intermediary constraints. We then infer tightness of intermediary constraints from the quantities of option trading during such periods. We show that a tightening of intermediary constraint according to our measure is associated with increasing option expensiveness, higher risk premia for a wide range of financial assets, deterioration in funding liquidity, and deleveraging of broker-dealers.
Number of Pages in PDF File: 68
Keywords: Intermediary constraint, tail risk, SPX option, return predictability, supply shocks, leverage
JEL Classification: E44, G12, G13, G20
Date posted: March 19, 2012 ; Last revised: January 20, 2016
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