How Do Households Suppress the Price of Tail Risk?

By: Laurent Calvet, Claire Célérier, Gordon Liao and Boris Vallée

Format:Print
| Language:English
| Pages:67

Abstract

This paper investigates the effects of the issuance of retail products with non-linear payoffs on option prices. For a given underlying asset, when the outstanding volume of products embedding a short-put position increases, implied volatility at the corresponding strike decreases. A similar pattern exists for the divident term structure: larger outstanding volumes of retail structured products are associated with a flattened divident term structured. A simple trading strategy exploiting this pattern leads to a Sharpe ratio above 2. These results are consistent with the existence of segmented markets and speak to the equilibrium effects of the retail demand for innovative securities.