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Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets

68 Pages Posted: 19 Mar 2012 Last revised: 20 Jan 2016

Hui Chen

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

Scott Joslin

University of Southern California

Sophie X. Ni

Hong Kong Baptist University (HKBU); Hong Kong University of Science and Technology

Date Written: January 19, 2016

Abstract

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.

Keywords: Intermediary constraint, tail risk, SPX option, return predictability, supply shocks, leverage

JEL Classification: E44, G12, G13, G20

Suggested Citation

Chen, Hui and Joslin, Scott and Ni, Sophie X., Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets (January 19, 2016). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2024416 or http://dx.doi.org/10.2139/ssrn.2024416

Hui Chen (Contact Author)

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

University of Southern California ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Sophie Xiaoyan Ni

Hong Kong Baptist University (HKBU) ( email )

Kowloon
Hong Kong

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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