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
November 14, 2014
AFA 2013 San Diego Meetings Paper
We propose a new measure for the variations in intermediary constraints by observing how financial intermediaries manage their tail risk exposures. Using a unique dataset on the trading activities between public investors and financial intermediaries in the market for deep out-of-the-money S&P 500 put options, we are able to isolate shocks to intermediary constraints by exploiting the price-quantity relations in this market. Besides the effects on option pricing, our measure of the shocks to intermediary constraints is a strong predictor of future returns for a wide range of financial assets, and it is associated with changes in the aggregate intermediary leverage. 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 aggregate risk premium.
Number of Pages in PDF File: 52
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: November 18, 2014
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