The Leverage Effect and the Basket-Index Put Spread

63 Pages Posted: 28 May 2017 Last revised: 19 Jul 2018

See all articles by Jennie Bai

Jennie Bai

Georgetown University - Department of Finance

Robert S. Goldstein

University of Minnesota - Twin Cities - Carlson School of Management; National Bureau of Economic Research (NBER)

Fan Yang

University of Connecticut - Department of Finance

Date Written: January 1, 2018

Abstract

Benchmark models that exogenously specify equity dynamics cannot explain the large spread in prices between put options written on individual banks and options written on the bank index during the financial crisis. However, theory requires that asset dynamics be specified exogenously and that endogenously determined equity dynamics exhibit a "leverage effect" that increases put prices by fattening the left tail of the distribution. The leverage effect is larger for puts on individual stocks than for puts on the index, thus increasing the basket-index spread. Time-series and cross-sectional variation in the leverage effect explains option prices well.

Keywords: basket-index put spread, bank, leverage effect, financial crisis, bailout, option pricing

JEL Classification: E44, G01, G13, G21, G28

Suggested Citation

Bai, Jennie and Goldstein, Robert S. and Yang, Fan, The Leverage Effect and the Basket-Index Put Spread (January 1, 2018). Journal of Financial Economics (JFE), 2018. Available at SSRN: https://ssrn.com/abstract=2972795 or http://dx.doi.org/10.2139/ssrn.2972795

Jennie Bai

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States

HOME PAGE: http://www.jenniebai.com

Robert S. Goldstein (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-624-8581 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Fan Yang

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
203
rank
146,408
Abstract Views
1,077
PlumX Metrics