Heterogeneous Beliefs and the Effect of Replicatable Options on Asset Prices

Alan Kraus; Maxwell Smith

doi:10.1093/rfs/9.3.723

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Heterogeneous Beliefs and the Effect of Replicatable Options on Asset Prices

Alan Kraus¹; Maxwell Smith^2,3

¹ University of British Columbia · ² Prudential Financial (United States) · ³ Institut Mines-Télécom Business School

Review of Financial Studies 1996

We present two ways in which trading in a replicatable option can affect the price process of the underlying asset. In the first situation, trading an option that each investor views as pay off redundant breaks a non-fully revealing equilibrium that exists when the option market is absent. The second situation involves a market that is dynamically complete without options, but in which introducing an option market allows self-confirming conjectures of additional uncertainty about the future price of the underlying asset. Heterogeneous beliefs play important though different roles in both situations.

DOI: 10.1093/rfs/9.3.723
Volume: 9 (3)
Pages: 723-756
Language: en
Export: BibTeX
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