Faculty Digital Archive

Archive@NYU >
Stern School of Business >
Finance Working Papers >

Please use this identifier to cite or link to this item: http://hdl.handle.net/2451/26977

Title: Who Buys and Who 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: 5-Sep-1996
Series/Report no.: FIN-96-025
Abstract: In this paper, we drive 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, the demand for these contracts is not explained by differences in the shape of utility functions. Rather, it is the degree tow 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/2451/26977
Appears in Collections:Finance Working Papers

Files in This Item:

File Description SizeFormat
wpa96025.pdf1.45 MBAdobe PDFView/Open

Items in Faculty Digital Archive are protected by copyright, with all rights reserved, unless otherwise indicated.


The contents of the FDA may be subject to copyright, be offered under a Creative Commons license, or be in the public domain.
Please check items for rights statements. For information about NYU’s copyright policy, see http://www.nyu.edu/footer/copyright-and-fair-use.html 
Valid XHTML 1.0 | CSS