This paper uses an asymptotically valid expansion to derive explicitly agent's individual demand schedules and then the equilibrium allocations in options. Agents derive financial and non-tradeable income over time; they can only partially offset the latter using bonds and stocks and the option increases their risk-spanning possibilities. However the option does not have to complete the market. The paper studies the interaction between demand/prices, analyzes the (necessary) conditions for trade and discusses the importance of heterogeneity. It also looks into the case in which there is only a spanning demand, but no risk-sharing demand in options and explains that teh financial innovation would then "fail," and discusses the conditions under which the option price is determined entirely by distributional characteristics.
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Find related papers by JEL classification: G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing G12 - Financial Economics - - General Financial Markets - - - Asset Pricing D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
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