Abstract:
The extant literature examines the interactions between funding liquidity and market volatility on the equity market. This paper extends the literature and investigates the interactions between funding liquidity and market volatility in the options market. The paper employs the Bayesian structural vector autoregression framework to examine the effects of funding liquidity shock to volatility demand, uncertainty, and risk aversion. We find that positive feedback exists between contraction in funding liquidity and volatility demand, uncertainty, and risk-aversion. Our results are robust to alternate specifications of uncertainty and risk-aversion measures, and alternative ordering of variables.