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Efficiency and options on the market index

Author

Listed:
  • Gabrielle Demange

    (Delta, 48 Boulevard Jourdan, F-75014 Paris, FRANCE)

  • Guy Laroque

    (I.N.S.E.E., Paris, FRANCE)

Abstract

In a static exchange economy, when all the endowments are issued as securities on a stock exchange, Pareto optimal allocations may be reached by trading options on the market index (see Breeden and Litzenberger (1978)). We extend this result when some of the risks cannot be exchanged on the market. Options on an appropriate index, which typically differs from the market index, depending on the correlation of the non-tradable risks with the exchanged securities, are still an appropriate tool to support a (constrained) efficient equilibrium. This suggests that the recent development of derivatives based on interest rates may be an efficient way to reach a Pareto optimal allocation of risks.

Suggested Citation

  • Gabrielle Demange & Guy Laroque, 1999. "Efficiency and options on the market index," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 14(1), pages 227-235.
    • Handle: RePEc:spr:joecth:v:14:y:1999:i:1:p:227-235
    Note: Received: June 16, 1997; revised version: July 25, 1997
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    Cited by:

    1. Alexandre M. Baptista, 2005. "Options And Efficiency In Multidate Security Markets," Mathematical Finance, Wiley Blackwell, vol. 15(4), pages 569-587, October.
    2. Alexandre Baptista, 2000. "Options and Efficiency in Multiperiod Security Markets," Econometric Society World Congress 2000 Contributed Papers 0299, Econometric Society.
    3. Baptista, Alexandre M., 2003. "Spanning with American options," Journal of Economic Theory, Elsevier, vol. 110(2), pages 264-289, June.

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