Endogenous Hazard: The Model Starts Listening to the Market

Description and use

The model now incorporates market state, especially dealer short‑gamma, to adjust hazard intensity, revealing hidden fragility in calm markets.

Problem

Traditional catastrophe models treat hazard as exogenous, ignoring how market state (e.g., dealer short‑gamma, volatility) amplifies crash severity.

Outcome

Integrating market state into the hazard layer reveals that calm markets can still harbor fragility via short‑gamma amplification, providing a more realistic risk assessment.

Workflow

• 1. Compute regime multiplier from VIX/SKEW: calm × 1.0, stressed × 1.5, panic × 2.5.
• 2. Estimate short‑gamma factor: 1 + max(0, ‑net_gamma) × 0.30, capped at 1.5.
• 3. Calculate event intensity: historical noise × regime multiplier × short‑gamma factor.
• 4. Apply intensity to replay historical crashes.
• 5. Validate that calm markets with expensive tail protection still show amplified hazard.
• 6. Document mechanism parameters and limits.
• 7. Iterate with new modules (discrete‑threshold selling, liquidation window).

Evidence

event intensity = historical noise × regime multiplier × short‑gamma factor

Source

Combined state intensity multiplier 1.1998

Source

The market was calm. The regime multiplier did nothing — it was 1.0. And yet the hazard layer still replayed historical crashes about 20% harder than before, purely because of the short‑gamma term.

Source