Prices and Volumes of Options: A Simple Theory of Risk Sharing When Markets are Incomplete

42 Pages Posted: 10 Nov 2010

See all articles by Francois Le Grand

Francois Le Grand

EMLYON Business School

Xavier Ragot

National Center for Scientific Research (CNRS)

Date Written: October 2010

Abstract

We present a simple theory of business-cycle movements of option prices and volumes. This theory relies on time-varying heterogeneity between agents in their demand for insurance against aggregate risk. Formally, we build an infinite-horizon model where agents face an aggregate risk, but also different levels of idiosyncratic risk. We manage to characterize analytically a general equilibrium in which positive quantities of derivatives are traded. This allows us to explain the informational content of derivative volumes over the business cycle. We also carry out welfare analysis with respect to the introduction of options, which appears not to be Pareto-improving.

Keywords: Option Pricing, Open Interest, Incomplete Markets

JEL Classification: G1, G10, E44

Suggested Citation

Le Grand, Fran├žois and Ragot, Xavier, Prices and Volumes of Options: A Simple Theory of Risk Sharing When Markets are Incomplete (October 2010). Available at SSRN: https://ssrn.com/abstract=1705987 or http://dx.doi.org/10.2139/ssrn.1705987

Fran├žois Le Grand (Contact Author)

EMLYON Business School ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

Xavier Ragot

National Center for Scientific Research (CNRS)

3, rue Michel-Ange
Paris cedex 16, 75794
France

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