Working Paper: NBER ID: w25573
Authors: Hui Chen; Scott Joslin; Sophie X. Ni
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.
Keywords: Crash Insurance; Financial Intermediaries; Risk Premia; Options Trading
JEL Codes: G01; G12; G17; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tightening of intermediary constraints (D10) | Increasing option expensiveness (G13) |
| Lower PNBO (L32) | Higher variance premiums (VP) (G19) |
| Lower PNBO (L32) | Higher future excess returns for various asset classes (G12) |
| Tightening of intermediary constraints (D10) | Higher future excess returns (G17) |