Abstract: We study interest rate risk sharing across the financial system using novel data on cross-sector interest rate swap positions. We show that pension funds and insurers (PF&I) are natural counterparties to banks and corporations: PF&I buy duration, whereas banks and corporations sell duration. However, demand is highly segmented across maturities, resulting in significant imbalances at various maturity points. We calibrate a preferred-habitat investors model with risk-averse arbitrageurs to study how demand imbalances interact with supply side constraints to impact swap spreads. Our framework helps quantify the spillover effects of demand shifts, which informs policy discussions on financial institutions’ hedging requirements.
Discussant: Kristy Jansen, University of Southern California
Abstract: Each time a stock is bought or sold by a passive index fund, who takes the other side? We use a combination of datasets to account for as many shares possible in every stock that changes hands amongst mutual funds, institutions, insiders, short sellers, and firms, with the remainder attributed to retail and small institutional investors. Over the past 20 years across all stocks, firms are the primary providers of shares to passive investors on average. In addition, firms are the most responsive to index funds’ buying: For every percentage point (pp) increase of index fund ownership in a stock, the firm itself responds at a rate of 0.69pps of share issuance. On a dollar basis, active mutual funds and financial institutions clear the market on average, but firms are still the most responsive, responding with $0.77 of greater share issuance or fewer shares repurchased for every additional $1 of index demand. The overarching Firm responsiveness story is robust to sample selection, treatment of outliers, return controls and fixed effects, and is consistent across industries and has been getting stronger over time.
Discussant: Matthew Ringgenberg, University of Utah
Abstract: Most U.S. equity index derivatives settle “a.m” on the 3rd Friday of each month via the constituent stocks’ opening trade price. We show that these prices are biased upward since the advent of overnight equity trading in the early 2000s. U.S. equity prices drift significantly upwards from Thursday close to 3rd Friday open and revert immediately after derivative payoffs are calculated. Consequently, equity futures and call option payoffs are biased upwards, while put option payoffs are biased downwards. We estimate a wealth transfer of around $4 billion per year in SPX options alone. These findings are consistent with channels relating to inventory management by option market makers or market manipulation by sophisticated investors during an illiquid trading period that precedes option settlement. We find support for these explanations in the positioning of market makers and likely manipulators the days before expiry. Both explanations rely on the existence of an illiquid trading period that precedes option settlement; thus, we argue that the current a.m settlement design is inefficient and propose alternative times of expiry that are not immediately after the illiquid overnight period.
