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Arrow-Debreu Meets Kyle: Price Discovery for Derivatives

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  • Christian Keller
  • Michael C. Tseng

Abstract

We analyze price discovery in a model where an agent has general private information regarding state probabilities and trades state-contingent claims. Our model unifies the elements of Arrow and Debreu (1954) and Kyle (1985). In the equivalent options formulation, the informed agent has general information regarding an underlying asset's payoff distribution and trades option portfolios. We characterize the informed demand, the price impact, and the information efficiency of prices. Our informed demand formula prescribes option strategies for trading on any given aspect of the underlying payoff distribution and explains those used in practice -- e.g., for volatility trading.

Suggested Citation

  • Christian Keller & Michael C. Tseng, 2023. "Arrow-Debreu Meets Kyle: Price Discovery for Derivatives," Papers 2302.13426, arXiv.org, revised Mar 2024.
  • Handle: RePEc:arx:papers:2302.13426
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