Gamma Fragility

60 Pages Posted: 16 Nov 2020 Last revised: 19 Nov 2020

See all articles by Andrea Barbon

Andrea Barbon

University of St. Gallen

Andrea Buraschi

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Date Written: November 5, 2020

Abstract

We build on a growing literature that studies the impact of market frictions on the dynamics of stock markets, such as momentum, price spirals, excess volatility, and investigate the potential feedback effects of delta-hedging in derivative markets on the underlying market. We document a link between large aggregate dealers' gamma imbalances in illiquid markets and intraday momentum/reversal and market fragility. This link is distinct from information frictions (adverse selection and private information) and funding liquidity frictions (margin requirement). We test our joint hypothesis using a large panel of index and equity options that we use to compute a proxy of aggregate gamma imbalance. We find supporting evidence that intra-day momentum (reversal) is explained by the interaction of negative (positive) aggregate gamma imbalance and market illiquidity. The effect is stronger for the least liquid underlying securities. The result helps to explain both intra-day volatility and autocorrelation of returns.

Keywords: Frictions, Momentum, Option Markets, Risk Management, Gamma Imbalance, Flash Crashes, Liquidity

Suggested Citation

Barbon, Andrea and Buraschi, Andrea, Gamma Fragility (November 5, 2020). University of St.Gallen, School of Finance Research Paper No. 2020/05, Available at SSRN: https://ssrn.com/abstract=3725454 or http://dx.doi.org/10.2139/ssrn.3725454

Andrea Barbon (Contact Author)

University of St. Gallen ( email )

Bodanstrasse 8
SIAW-HSG
St.Gallen, 9000
Switzerland

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

Andrea Buraschi

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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