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Long-term information, short-lived derivative securities

Author

Listed:
  • Dan Bernhardt

    (University of Illinois)

  • Ryan Davies

    (Queen's University)

  • John Spicer

    (Europe Economics)

Abstract

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.

Suggested Citation

  • Dan Bernhardt & Ryan Davies & John Spicer, 2000. "Long-term information, short-lived derivative securities," Working Papers 994, Queen's University, Department of Economics.
  • Handle: RePEc:qed:wpaper:994
    as

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    File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_994.pdf
    File Function: First version 2000
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    References listed on IDEAS

    as
    1. Neuberger, Anthony, 1999. "Hedging Long-Term Exposures with Multiple Short-Term Futures Contracts," Review of Financial Studies, Society for Financial Studies, pages 429-459.
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    3. Dow, James & Gorton, Gary, 1994. " Arbitrage Chains," Journal of Finance, American Finance Association, vol. 49(3), pages 819-849, July.
    4. Back, Kerry, 1993. "Asymmetric Information and Options," Review of Financial Studies, Society for Financial Studies, pages 435-472.
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    6. 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.
    7. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
    8. 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.
    9. 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.
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    12. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, pages 148-153.
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    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Private information; liquidity; derivative securities; strategic trade;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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