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What Drives Index Options Exposures?
[Uncertainty and economic activity: evidence from business survey data]

Author

Listed:
  • Timothy Johnson
  • Mo Liang
  • Yun Liu

Abstract

This paper documents the history of aggregate positions in US index options and investigates the driving factors behind use of this class of derivatives. We construct several measures of the magnitude of the market and characterize their level, trend, and covariates. Measured in terms of volatility exposure, the market is economically small, but it embeds a significant latent exposure to large price changes. Out-of-the-money puts are the dominant component of open positions. Variation in options use is well described by a stochastic trend driven by equity market activity and a significant negative response to increases in risk. Using a rich collection of uncertainty proxies, we distinguish distinct responses to exogenous macroeconomic risk, risk aversion, differences of opinion, and disaster risk. The results are consistent with the view that the primary function of index options is the transfer of unspanned crash risk.

Suggested Citation

  • Timothy Johnson & Mo Liang & Yun Liu, 2018. "What Drives Index Options Exposures? [Uncertainty and economic activity: evidence from business survey data]," Review of Finance, European Finance Association, vol. 22(2), pages 561-593.
    • Handle: RePEc:oup:revfin:v:22:y:2018:i:2:p:561-593.
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    File URL: http://hdl.handle.net/10.1093/rof/rfw061
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    References listed on IDEAS

    as
    1. Bates, David S., 2008. "The market for crash risk," Journal of Economic Dynamics and Control, Elsevier, vol. 32(7), pages 2291-2321, July.
    2. R?diger Bachmann & Steffen Elstner & Eric R. Sims, 2013. "Uncertainty and Economic Activity: Evidence from Business Survey Data," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(2), pages 217-249, April.
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    More about this item

    Keywords

    Index options; Quantities; Derivatives risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

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