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Heterogeneous Beliefs and the Effect of Replicatable Options on Asset Prices

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  • Kraus, Alan
  • Smith, Maxwell
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    Abstract

    We present two ways in which trading in a replicatable option can affect the price process of the underlying asset. in the first situation, trading an option that each investor views as pay-off redundant breaks a non-fully revealing equilibrium that exists when the option market is absent. The second situation involves a market that is dynamically complete without options, but in which introducing an option market allows self-confirming conjectures of additional uncertainty about the future price of the underlying asset. Heterogeneous beliefs play important though different roles in both situations. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal Review of Financial Studies.

    Volume (Year): 9 (1996)
    Issue (Month): 3 ()
    Pages: 723-56

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    Handle: RePEc:oup:rfinst:v:9:y:1996:i:3:p:723-56

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    Cited by:
    1. Judd, Kenneth L. & Leisen, Dietmar P.J., 2010. "Equilibrium open interest," Journal of Economic Dynamics and Control, Elsevier, vol. 34(12), pages 2578-2600, December.
    2. Amir Rubin & Daniel Smith, 2010. "Comparing Different Explanations of the Volatility Trend," NCER Working Paper Series 68, National Centre for Econometric Research.
    3. Alejandro Bernales & Massimo Guidolin, 2013. "The Effects of Information Asymmetries on the Success of Stock Option Listings," Working Papers 484, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    4. Jun Pan & Allen Poteshman, 2004. "The Information of Option Volume for Future Stock Prices," NBER Working Papers 10925, National Bureau of Economic Research, Inc.
    5. Hiremath, Gourishankar S, 2009. "Effects of Option Introduction on Price and Volatility of Underlying Assets - A Review," MPRA Paper 46512, University Library of Munich, Germany.
    6. Badreddine, Sina & Galariotis, Emilios C. & Holmes, Phil, 2012. "The relevance of information and trading costs in explaining momentum profits: Evidence from optioned and non-optioned stocks," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(3), pages 589-608.

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