Imperfect Competition on Stock Markets: the Impact of Options at the Exercise Date
Derivative securities may incite traders to manipulate the price of the underlying assets. We analyze this issue at the exercise date of an European option on a stock, when the stock price determines the option payoff. Traders submit their demand for the stock to an auctioneer who selects a price that clears the market. Liquidity is ensured by rational, small competitive traders. We show that the equilibrium process is highly affected by the option holdings of non competitive traders. Equilibrium demand schedules may be locally increasing in prices, thereby inducing clearing prices to be discontinuous with respect to competitive demand. Moreover, long positions on the option generate positive externalities among non-competitive traders, which may result in multiple equilibria may exist. These potentially destabilizing effects of imperfect competition are due to the convexity of option payoffs and do not occur with futures.
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