Why Does Volatility Demand Fall During Market Turmoil? A Market Maker Perspective
Prof. Kris JACOBS
C.T. Bauer Chair in Finance
University of Houston
Date: 6 December 2024 (Friday)
Time: 10:30 to 12:00
Venue: E22-G010
Host: Prof. Endong YANG, Assistant Professor in Finance
Abstract
End users typically are net long VIX call options to hedge against market downturns, but paradoxically reduce these net long positions during periods of market turmoil. We explain this puzzle by considering a demand system with different demand curves for market makers and end users in a zero net supply market, and we use the time series of end users’ and market makers’ net positions to estimate the latent demand curves. Our findings indicate that both demand curves shift right during periods of market turmoil, but market maker demand reacts more strongly, especially for options with short maturities. These high-risk periods are therefore characterized by reduced net long positions of end users, higher volatility returns, and wider bid-ask spreads. Unconditionally, we find that market maker demand increases (or equivalently, supply decreases) when inventory constraints and expected returns on volatility are high. Overall, our findings highlight the active role of market makers in shaping market equilibrium, as they manage inventory and profits while maintaining continuous market liquidity.
Speaker
Prof. Kris JACOBS holds the C.T. Bauer Chair in Finance at the Bauer College of Business, University of Houston. He received his Ph.D. from the University of Pittsburgh and his undergraduate and Master’s degrees from the University of Leuven in Belgium. His research interests include asset valuation, derivatives and fixed income markets, credit risk, risk management, financial econometrics, and commodity markets. His research is very widely published and cited in all leading journals in finance such as the Journal of Finance, Review of Financial Studies, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, and Management Science. He is also the associate editor for several journals such as the Journal of Banking and Finance, Journal of Empirical Finance, Financial Management, and Journal of Applied Econometrics.
All are welcome!
