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Transaction Risk, Derivative Assets, and Equilibrium

Author

Listed:
  • H. Henry Cao

    () (Cheung Kong Graduate School of Business (CKGSB), Oriental Plaza, Tower E3, 3F, One East Chang An Avenue, Beijing 100738, P. R. China)

  • Dongyan Ye

    (Cheung Kong Graduate School of Business (CKGSB), Oriental Plaza, Tower E3, 3F, One East Chang An Avenue, Beijing 100738, P. R. China)

Abstract

We describe a rational expectations model in which there is not only asymmetric information about payoffs but also asymmetric information about the preference, proportion and precision of private information of investors. We define this payoff-irrelevant risk as transaction risk, which is described by market state variables unrelated to payoffs. When derivative assets are introduced, the prices of the derivative assets can reveal information about transaction risk. Due to the informational role of derivative-asset prices, introducing derivative assets can increase social welfare and the price of the underlying asset even though no investors are trading in these derivative assets.

Suggested Citation

  • H. Henry Cao & Dongyan Ye, 2016. "Transaction Risk, Derivative Assets, and Equilibrium," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(01), pages 1-20, March.
  • Handle: RePEc:wsi:qjfxxx:v:06:y:2016:i:01:n:s2010139216500014
    DOI: 10.1142/S2010139216500014
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    References listed on IDEAS

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