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Prices and volumes of options: A simple theory of risk sharing when markets are incomplete

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  • Le Grand, F.
  • Ragot, X.

Abstract

We present a simple theory of business-cycle movements of option prices and volumes. This theory relies on time-varying heterogeneity between agents in their demand for insurance against aggregate risk. Formally, we build an infinite-horizon model where agents face an aggregate risk, but also different levels of idiosyncratic risk. We manage to characterize analytically a general equilibrium in which positive quantities of derivatives are traded. This allows us to explain the informational content of derivative volumes over the business cycle. We also carry out welfare analysis with respect to the introduction of options, which appears not to be Pareto-improving.

Suggested Citation

  • Le Grand, F. & Ragot, X., 2010. "Prices and volumes of options: A simple theory of risk sharing when markets are incomplete," Working papers 302, Banque de France.
    • Handle: RePEc:bfr:banfra:302
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    References listed on IDEAS

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    1. Challe, Edouard & Le Grand, François & Ragot, Xavier, 2013. "Incomplete markets, liquidation risk, and the term structure of interest rates," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2483-2519.
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    More about this item

    Keywords

    Option Pricing; Open Interest; Incomplete Markets.;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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