Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets
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.
We thank Tobias Adrian, David Bates, Robert Battalio, Geert Bekaert, Harjoat Bhamra, Ken French, Nicolae Garleanu, Zhiguo He, Boris Ilyevsky, Gary Katz, Bryan Kelly, Lei Lian, Andrew Lo, Dmitriy Muravyev, Jun Pan, Lasse Pedersen, Steve Ross, Paul Stephens, Ken Singleton, Emil Siriwardane, Moto Yogo, Hao Zhou, as well as participants at numerous conferences and seminars for comments, and we thank Ernest Liu for excellent research assistance. We also acknowledge financial support from Hong Kong RGC (644311). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Hui Chen & Scott Joslin & Sophie Xiaoyan Ni, 2019. "Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets," The Review of Financial Studies, vol 32(1), pages 228-265.