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Long-term information, short-lived derivative securities

  • Dan Bernhardt

    (University of Illinois)

  • Ryan Davies

    (Queen's University)

  • John Spicer

    (Europe Economics)

This paper explores strategic trade in short-lived derivative securities by agents that possess long-term information about an underlying asset. In contrast to trading equity, where an informed agent will ultimately benefit from his trades, trading short-lived securities is profitable only if the price impounds the private information before expiry. A consequence is that a risk neutral informed agent's holdings of the short-lived security affect his trading behavior: Past informed trading leads to greater future informed trading. The shorter horizon in which information must be impounded for a short-lived security to pay off makes an informed agent more reluctant to trade at earlier dates. By characterizing the conditions under which liquidity traders choose to incur extra costs to roll over their short-term positions rather than trade in longer-term derivative securities, we provide a possible explanation for why most markets for longer-term derivative securities have little liquidity and large bid-ask spreads.

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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 994.

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Length: 47 pages
Date of creation: Aug 2000
Date of revision:
Handle: RePEc:qed:wpaper:994
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  1. Back, Kerry, 1993. "Asymmetric Information and Options," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 435-72.
  2. Michael Fleming & Asani Sarkar, 1999. "Liquidity in U.S. Treasury Spot and Futures Markets," CGFS Papers chapters, in: Bank for International Settlements (ed.), Market Liquidity: Research Findings and Selected Policy Implications, volume 11, pages 1-14 Bank for International Settlements.
  3. Neuberger, Anthony, 1999. "Hedging Long-Term Exposures with Multiple Short-Term Futures Contracts," Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 429-59.
  4. James Dow & Gary Gorton, . "Arbitrage Chains," Rodney L. White Center for Financial Research Working Papers 06-93, Wharton School Rodney L. White Center for Financial Research.
  5. Foster, F Douglas & Viswanathan, S, 1996. " Strategic Trading When Agents Forecast the Forecasts of Others," Journal of Finance, American Finance Association, vol. 51(4), pages 1437-78, September.
  6. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  7. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  8. Kerry Back & C. Henry Cao & Gregory A. Willard, 2000. "Imperfect Competition among Informed Traders," Journal of Finance, American Finance Association, vol. 55(5), pages 2117-2155, October.
  9. Foster, F. Douglas & Viswanathan, S., 1994. "Strategic Trading with Asymmetrically Informed Traders and Long-Lived Information," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(04), pages 499-518, December.
  10. Biais, Bruno & Hillion, Pierre, 1994. "Insider and Liquidity Trading in Stock and Options Markets," Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 743-80.
  11. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-53, May.
  12. David Easley & Maureen O'Hara & P.S. Srinivas, 1998. "Option Volume and Stock Prices: Evidence on Where Informed Traders Trade," Journal of Finance, American Finance Association, vol. 53(2), pages 431-465, 04.
  13. Seppi, Duane J, 1990. " Equilibrium Block Trading and Asymmetric Information," Journal of Finance, American Finance Association, vol. 45(1), pages 73-94, March.
  14. Holden, Craig W & Subrahmanyam, Avanidhar, 1992. " Long-Lived Private Information and Imperfect Competition," Journal of Finance, American Finance Association, vol. 47(1), pages 247-70, March.
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