Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets / Hui Chen, Scott Joslin, Sophie X. Ni.

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Chen, Hui

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w25573.Publication details: Cambridge, Mass. National Bureau of Economic Research 2019.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We propose a new measure of financial intermediary constraints based on how the intermediaries manage their tail risk exposures. Using data 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. 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 broker-dealer deleveraging.

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February 2019.

We propose a new measure of financial intermediary constraints based on how the intermediaries manage their tail risk exposures. Using data 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. 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 broker-dealer deleveraging.