Derivative-Market Leverage and Risk Premia Implications

We use the futures commission merchants (FCMs) reports released by CFTC to construct a frequent (monthly) and timely (one-month delay) market-level leverage measure, based on the aggregate margin of market participants. The derivative-market leverage negatively (positively) predicts returns of risky (safe) assets, as a market indicator of the investors' risk tolerance. This effect is robust across both futures and spot markets, persistent up to one year, and stronger during the deleveraging periods. The derivative-market leverage is responding to market uncertainty, co-moves with economic activities, but preceding capital demands. These results are consistent with
a stylized model of the futures and spot markets.