The Market Impact of Options

55 Pages Posted: 14 Jul 2016 Last revised: 3 May 2017

See all articles by Feng Gao

Feng Gao

Tsinghua University

Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)

Date Written: May 3, 2017

Abstract

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.

Suggested Citation

Gao, Feng and Wang, Jiang, The Market Impact of Options (May 3, 2017). Available at SSRN: https://ssrn.com/abstract=2808340 or http://dx.doi.org/10.2139/ssrn.2808340

Feng Gao (Contact Author)

Tsinghua University ( email )

Beijing, 100084
China

Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E62-614
100 Main Street
Cambridge, MA 02142
United States
617-253-2632 (Phone)
617-258-6855 (Fax)

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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