Asymmetric information about volatility and option markets
AbstractThis paper develops a model of asymmetric information in which an investor has information regarding the future volatility of the price process of an asset but not the future asset price. It is shown that there exists an equilibrium in which the investor trades an option on the asset and expressions for the equilibrium option price and the dynamic trading strategy of the investor are derived endogenously. It is found that the expected volatility of the underlying asset increases in the net order flow in the option market. Also, the depth of the option market is smaller when there is more uncertainty about the variance of the underlying asset, which is conceptually consistent with empirical findings in the equity option market.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 95-19.
Date of creation: 1995
Date of revision:
Publication status: Published in Journal of Derivatives Research, 1999
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570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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