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A Partial Equilibrium Model of Option Markets

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  • Dietmar P.J. Leisen and Kenneth L. Judd

Abstract

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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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2001 with number 219.

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Date of creation: 01 Apr 2001
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Handle: RePEc:sce:scecf1:219

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Web page: http://www.econometricsociety.org/conference/SCE2001/SCE2001.html
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Related research

Keywords: heterogeneity; equilibrium; demand; supply; prices;

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Cited by:
  1. Niehaus, Frank, 2001. "The Influence of Heterogeneous Preferences on Asset Prices in an Incomplete Market Model," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Leibniz Universität Hannover dp-234, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  2. Sohnke M. Bartram & Frank R. Fehle, 2003. "Alternative Market Structures for Derivatives," Finance 0311007, EconWPA, revised 12 Dec 2003.
  3. Sohnke M. Bartram & Frank R. Fehle, 2003. "Competition among Alternative Option Market Structures: Evidence from Eurex vs. Euwax," Finance 0307005, EconWPA, revised 24 Jul 2003.

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