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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27127
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| Title: | Who Buys and Sells Options: The Role and Pricing of Options in an
Economy with Background Risk |
| Authors: | Franke, Gunter
Stapleton, Richard C.
Subrahmanyam, Marti G. |
| Issue Date: | 4-Dec-1995 |
| Series/Report no.: | FIN-95-021 |
| Abstract: | In this paper, we derive an equilibrium in which some investors buy
call/put options on the market portfolio while others sell them. Also,
some investors supply and others demand forward contracts. Since
investors are assumed to have similar risk-averse preferences, demand
for these contracts is not explained by differences in the shape of
utility functions. Rather, it is the degree to which agents face other,
non-hedgeable, background risks that determines their risk-taking
behavior in the model. We show that investors with low or no background
risk have a concave sharing rule, i.e., they sell options on the market
portfolio, whereas investors with high background risk have a convex
sharing rule and buy these options. A general increase in background
risk in the economy reduces the forward price of the market portfolio.
Furthermore, the prices of put options rise and the prices of call
options fall. Investors without background risk then react by choosing a
sharing rule with higher slope and concavity. |
| URI: | http://hdl.handle.net/2451/27127 |
| Appears in Collections: | Finance Working Papers
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