The Market Impact of Options
55 Pages Posted: 14 Jul 2016 Last revised: 3 May 2017
Date Written: May 3, 2017
This article develops a noisy rational expectations model to examine the effect of introducing options on the financial market in an economy with heterogeneous uncertain endowment and information. The model is shown to have a unique equilibrium and demonstrates that adding options cannot always reveal additional directional information that is not contained in the price of an underlying asset. However, the option is not redundant because it is a security for betting volatility. The introduction of options generally changes the stock price and trading of the asset, but the impact on the stock price is small if volatility is a publicly known constant. Furthermore, introducing options is not always Pareto-improving and may cause certain agents to be worse off.
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