Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk
University of Konstanz - Department of Economics
Richard C. Stapleton
University of Strathclyde, Glasgow - Department of Accounting and Finance
Marti G. Subrahmanyam
New York University - Stern School of Business
Journal of Economic Theory, 1998
In this paper, we derive an equilibrium in which some investors buy call/put options on the market portfolio while others sell them. Since investors are assumed to have similar risk-averse preferences, the demand for these contracts is not explained by differences in the shape of utility functions. Rather, it is the degree to which agents face other, non hedgeable, background risks that determines their risk-taking behavior in the model. We show that investors with low or no background risk have a concave sharing rule, i.e., they sell options on the market portfolio, whereas investors with high background risk have a convex sharing rule and buy these options.
JEL Classification: G13Accepted Paper Series
Date posted: May 20, 1998
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