Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk

31 Pages Posted: 11 Nov 2008

See all articles by Marti G. Subrahmanyam

Marti G. Subrahmanyam

New York University (NYU) - Department of Finance

Günter Franke

affiliation not provided to SSRN

Richard C. Stapleton

University of Strathclyde - Department of Accounting and Finance

Multiple version iconThere are 3 versions of this paper

Date Written: February 1998

Abstract

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.

Suggested Citation

Subrahmanyam, Marti G. and Franke, Günter and Stapleton, Richard C., Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk (February 1998). NYU Working Paper No. FIN-98-063. Available at SSRN: https://ssrn.com/abstract=1297791

Marti G. Subrahmanyam (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)

Günter Franke

affiliation not provided to SSRN

No Address Available

Richard C. Stapleton

University of Strathclyde - Department of Accounting and Finance ( email )

Curran Building
100 Cathedral Street
Glasgow G4 0LN
United Kingdom
+44 1524 381 172 (Phone)
+44 1524 846874 (Fax)

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