IDEAS home Printed from https://ideas.repec.org/p/chf/rpseri/rp1436.html
   My bibliography  Save this paper

Price Discovery through Options

Author

Listed:
  • Semyon MALAMUD

    (Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute)

Abstract

How does private information get incorporated into option prices? To study this question, I develop a non-linear, noisy rational expectations equilibrium model with asymmetric information and a full menu of call and put options available for trading. The model allows for an arbitrary distribution of the underlying payoff and general trader preferences. All equilibrium prices and portfolios are obtained in closed form. Learning from option prices is characterized explicitly in terms of a novel object, the second derivative of the signal-to-noise ratio, whose sign determines whether particular shapes of option prices are "good news". I show that there is a major difference in equilibrium behaviour for constant absolute risk aversion (CARA) and non-CARA preferences due to feedback effects between wealth, price discovery, and private information: First, if informed traders have non-CARA preferences, strong-form efficiency is always obtained, independent of the amount of noise trading. Second, when informed traders have CARA preferences, the nature of equilibrium changes drastically with wealth effects of uninformed trading: If the latter have non-CARA preferences, weak-form efficiency fails and option prices are not sufficient to recover the information contained in the aggregate demand.

Suggested Citation

  • Semyon MALAMUD, 2014. "Price Discovery through Options," Swiss Finance Institute Research Paper Series 14-36, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1436
    as

    Download full text from publisher

    File URL: http://ssrn.com/abstract=2440677
    Download Restriction: no
    ---><---

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Georgy Chabakauri & Kathy Yuan & Konstantinos E Zachariadis, 2022. "Multi-asset Noisy Rational Expectations Equilibrium with Contingent Claims [A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(5), pages 2445-2490.

    More about this item

    Keywords

    options; asymmetric information; learning; informational efficiency;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:chf:rpseri:rp1436. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Ridima Mittal (email available below). General contact details of provider: https://edirc.repec.org/data/fameech.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.