The Supply and Demand of S&P 500 Put Options
George Constantinides () and
No 21161, NBER Working Papers from National Bureau of Economic Research, Inc
We document that the implied volatility skew of S&P 500 index puts is non-decreasing in the disaster index and risk-neutral variance, contrary to the implications of a broad class of no-arbitrage models. The key to the puzzle lies in recognizing that, as the disaster risk increases, customers demand more puts as insurance while market makers become more credit-constrained in writing puts. The resulting increase in the equilibrium price is more pronounced in out-of-the-money than in-the-money puts, thereby steepening the implied volatility skew and resolving the puzzle. Consistent with the data, the model also implies that the equilibrium net buy of puts is decreasing in the disaster index, variance, and their price. The data shows a significant decreasing relationship between the IV skew and the net buy and no relationship in other periods, also explained by the model.
JEL-codes: G10 G12 G13 G23 (search for similar items in EconPapers)
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Published as George M. Constantinides & Lei Lian, 2021. "The Supply and Demand of S&P 500 Put Options," Critical Finance Review, vol 10(1), pages 1-20.
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