Price taking behavior and trading in options

Equilibrium prices of options are arbitrage prices in economies in which prices are determined endogenously and all agents are price takers. This paper shows that the price taking assumption in options' markets is unreasonable because a small agent can make huge gains by not being a price taker.     

The credit market and rural development: A model of a Land Resettlement Scheme

Many markets in developing countries are imperfect, and governments often attmept to eliminate imperfections. The policy implications of completing an incomplete market have not, however, been considered theoretically in the literature. This paper fills the gap, using a model of the credit market in a land resettlement scheme. The major conclusion contradicts a common assumption of the credit rural literature, namely that freely available credit will achieve development objectives. Opening the credit market will contribute to broad objectives such as increasing the options available to settlers, but it will not necessarily achieve narrower objectives such as raising the output of a particular crop.     

Intraday hedging with financial options: the case of electricity

As market intermediaries, electricity suppliers purchase electricity from the wholesale market or self-generate to deliver their customers. However, electricity suppliers are uncertain about how much electricity their residential customers will use at any hour of the day until they actually turn switches on. While demand uncertainty is a common feature of all commodity markets, suppliers generally rely on storage to manage it. Singularly, electricity suppliers are exposed to joint volumetric and price risk on an hourly basis given the physical attributes of electricity. In the literature on electricity markets, few articles compare the efficiency of forward contracts, options and physical assets (i.e. power plants) within intraday hourly hedging portfolios, whereas electricity markets are precisely hourly markets. We analyse portfolios made of forwards, options and/or power plants for specific hourly clusters (9 am, 12 pm, 18 pm, 9 pm) based on electricity market data from 2013 to 2015 from the integrated German–Austrian spot market. Through a VaR model, we prove that intraday hedging with forwards is structurally inefficient compared to financial options and physical assets, no matter the cluster hour. Moreover, our results demonstrate the contribution of ‘out of the money’ options for all hours within volatile spot markets.     

Spanning with American options

In this paper, we investigate the existence of multiperiod American options generating dynamically complete markets. We show that if a primitive security separates states at the terminal date, then generically there exist multiperiod American options on that security generating dynamically complete markets. We also provide an example of an economy in which multiperiod American options on a primitive security generate dynamically complete markets, while multiperiod European options do not.     

Optimal Trade Policies and Production Technology in Vertically Related Markets*

This paper shows that optimal trade policies for vertically related markets depend crucially on production technology. By employing a production function with variable‐coefficient technology, it shows that return to scale is crucial in determining the direction of government intervention. Therefore, the assumption of fixed‐coefficient production technologies, which has been popular in industrial organization and trade literature when modeling vertically related markets, should be used with caution.     

Constant returns to scale and competitive equilibrium under uncertainty

This paper considers the implications of the assumption of constant returns to scale in expected utility maximizing models of the competitive firm or industry in which markets for risk are absent. Under widely used assumptions about risk preferences it is shown that with constant returns to scale average profits are more than necessary to cover the implicit costs of risk-bearing. When the free entry of identical firms is possible this assumption about technology is shown to be incompatible with the assumption that entrepreneurs are risk averse.     

Derivative securities and cash market stability

This study investigates the effect of introducing interest-rate futures and options on the price variances in related financial cash markets. Standard research approaches to this issue relate cash-price stability before the introduction of futures and options trading to cash-price stability after trading in the derivative security begins. However, controlling for the additional factors that may also effect cash markets is difficult. The approach employed here to deal with this obstacle is motivated by recent theoretical research relating cash and futures markets, but hitherto not operationalized to empirically test for a relationship between the markets. Varying-parameter models of (1) the demand for short-term Treasury securities, (2) the demand for large time-deposits, and (3) the supply of large time-deposits are specified such that changes in the parameters imply changes in the volatility of the cash price. These parameters are modelled as functions of the trading volume of interest-rate futures and options, thereby enabling a direct test of the hypothesis that trading volume in these derivative securities influences the behaviour of cash-market participants, and therefore, cash-price volatility. We find no convincing evidence that the level of activity in interest-rate futures and options has a significant effect on these cash markets.     

A New Look at Old Issues: Keynesian Unemployment Revisited

Economists have long sensed that the failure of goods markets to clear is a prime reason for the emergence of unemployment. The novel feature of this paper is that it discovers a new theoretical basis proving this assumption. The paper claims that in a permanently growing economy, unemployment may be due to the failure of the markets to provide consumers with ever‐new varieties of consumption goods. As the difference between desired and available product widens, effective demand declines, leading on the one hand to unemployment, which exhibits a decisive Keynesian flavour as it is the result of goods markets failures, and on the other hand to an increase in involuntary savings, which provide the financial basis to foster innovation and growth. As the higher growth rate increases the probability of failures in effective demand, it further increases unemployment and increases involuntary savings, resulting in a finite multiplier process.     

Volatility transmission to the fine wine market

The goal of this paper is to explore volatility transmission from various markets to the fine wine market. Knowledge of these channels for transmitting volatility to the wine market allows practitioners to anticipate the future volatility and the consequences of a shock on the wine market, to develop their investment strategy and diversify their risk. We especially analyse the impact of U.S. markets (i.e. art, commodities, credit, financial and real estate) during the 2007–2017 period. We shed additional light on how the volatility of the fine wine market varies during an extended period including a financial crisis. Our results indicate that, in the short-term, volatility is transmitted with a negative effect through the financial and commodity markets and with a positive effect through the art, residential real estate, and credit default markets. In the long-term, the wine market is impacted by all other markets. We show that correlations are time-varying.     

Why is there controversy regarding China’s staple grain food market integration? Evidence and implication from price convergent club analysis

There remains ongoing controversy regarding the degree to which Chinese food markets are integrated. Some economists conclude that China’s grain economy is well integrated, while others argue that China’s gradual reforms have led to fragmented domestic markets while others conclude that previous studies have produced mixed results. To reconcile the debate, this article models and analyses the behaviour of China’s food grain retail markets by testing for the existence of the convergent price clustering clubs using appropriate econometric methods and price data over 1997–2010. The article finds evidence as to why the controversy remains by identifying a number of small divergent price clustering clubs where it is hard to conclude that China’s food grain markets are fully integrated. However, given that large convergent clustering clubs were also identified, it can be concluded that the degree to which Chinese grain food retail markets are integrated is ‘high’. This finding is important for those who plan to investigate the economic behaviour of grain production under the assumption of a pure, fully integrated, food market economy in China.     

Valuing Options in Water Markets: A Laboratory Investigation

Risk and reliability dominate water supply discussions in the arid western United States due to increasing demand and finite, weather-dependent supply. Water markets have evolved in this region so agencies could meet this growing demand. In a few instances, water agencies turned to contractual mechanisms such as options to manage supply. As demand continues to grow option markets and other novel approaches to allocating water may become increasingly popular. We utilize experimental economics to analyze the effect of annual options on water markets in the absence of sufficient real-world data for conventional econometric analysis. We find gains from trade are higher when options can be traded. Additionally, gains are more evenly distributed, particularly with a dominant buyer and many sellers. Findings suggest option markets may be a viable choice as policymakers prepare for future droughts.     

Rolling settlement and market liquidity

This paper investigates the impact on UK stock and option markets of the change from an account based settlement system to a rolling settlement procedure. Such a change increases the transaction costs of short-term margin traders, and is likely to impact on the liquidity of the underlying market, as well as trading in the options market. Evidence is presented that the settlement procedure does impact on the liquidity of the market. Further, we find that rolling settlement increased market liquidity, consistent with the exit of margin traders as a result of the increase in short selling costs. Associated with this increase in liquidity is a significant reduction in nonoptionable stock trading volume, implying that margin trading may have been more prevalent in stocks without options. Finally, it is shown that while trading in stock options increased, the volatilities implied from call and put option prices indicate that put options have become relatively more expensive. This reflects the change in demand induced by the new settlement procedure, especially in terms of the increase in short selling costs.     

On the Non-Existence of Redundant Options

In a seminal paper, Ross (Q J Econ 90:75–89, 1976) shows that if security markets are resolving, then there exist (non-redundant) options that generate complete security markets. Complementing his work, Aliprantis and Tourky (2002) show that if security markets are strongly resolving and the number of primitive securities is less than half the number of states, then every option is non-redundant. Our paper extends Aliprantis and Tourky’s result to the case when their condition on the number of primitive securities is not imposed. Specifically, we show that if there exists no binary payoff vector in the asset span, then for each portfolio there exists a set of exercise prices of full measure such that any option on the portfolio with an exercise price in this set is non-redundant. Since the condition that there exists no binary payoff vector in the asset span holds generically, redundant options are thus rare. I am grateful to an anonymous referee for very helpful comments. Research support from the School of Business at The George Washington University is gratefully acknowledged     

High profit equilibria in directed search models

We consider a model of directed search where the sellers are allowed to post mechanisms with entry fees. Regardless of the number of buyers and sellers, the sellers are able to extract all the surplus of the buyers by introducing entry fees and making price schedules positively sloped in the number of buyers arriving to their shops. This is in contrast to results that are achieved for large markets under the assumption that sellers cannot influence the utility of any particular buyer (market utility assumption), in which case buyers obtain strictly positive rents. If there is a bound on the prices or on the entry fees that can be charged, then the equilibrium with full rent extraction does not exist any more, and the market utility assumption is restored for large markets.     

Duration of bankruptcy proceedings and monetary policy effectiveness

A common assumption in well-known costly-state-verification frameworks is that when a borrower defaults, creditors receive a payoff immediately (after incurring bankruptcy costs). While this assumption enhances tractability, it is unrealistic given the considerable delays in the actual practice of bankruptcy. In this paper, I identify the duration of bankruptcy proceedings as an additional source of friction in financial markets and investigate the relationship between this friction and the effectiveness of monetary policy by using U.S. state-level data. Consistent with the commonly-observed positive relationship between the degree of standard financial frictions and the amplitude of macroeconomic responses, I find that U.S. monetary policy is most effective in states with longer bankruptcy proceedings.     

Interpreted and generated signals

Private information is typically modeled as signals. A joint probability distribution captures relationships between signals and between signals and relevant variables. In this paper, we define and contrast two types of signals: generated and interpreted. We demonstrate that even though the standard assumption of conditional independence is a reasonable benchmark assumption for generated signals, it imposes a specific, and unlikely structure on interpreted signals. We also show that independent interpreted signals are negatively correlated in their correctness, but generated signals can be independent. Our findings may limit the contexts in which many models of information aggregation and strategic choices in auctions, markets, and voting apply.     

Socio-economic Research in Personnel versus Personnel Economics

This paper argues that personnel economics is still dominated by the assumptions of orthodox microeconomics, and also that newer fields such as transaction cost theory are far removed from socio-economics. Personnel economics is characterised by assumptions of unbounded rationality, stable preferences and functioning markets; power differences are seen as unimportant for explanations. By contrast, a socio-economic perspective works with the assumption of bounded rationality; it takes preferences into account, assumes that markets are characterised by ‘non-equilibrium’ states and power differences. The paper outlines a socio-economic mode of explanation and suggests that any explanation should include assumptions about three theoretical mechanisms: pursuit of utility, power and sense-making.     

On the completeness of complete markets

We reconsider the allocational invariance of equilibria to different formulations of market completeness. We identify the so-far neglected assumption of sophisticated behavior as being crucial. First, the Arrow–Debreu setting is considered, where markets do not reopen in the future. Second, sequentially complete markets are analyzed, where goods on the spot markets and all contingent one-period ahead commodities can be traded in every state. Finally, complete markets are analyzed, where all possible contingent commodities can be traded at every state. Preferences may be time-consistent or time-inconsistent. A distinction is made between naïve and sophisticated behavior.     

Observable restrictions of general equilibrium models with financial markets

This paper examines whether general equilibrium models of exchange economies with incomplete financial markets impose restrictions on prices of commodities and assets given the stochastic processes of dividends and aggregate endowments. We show that the assumption of time-separable expected utility implies restriction on the cross-section of asset prices as well as on spot commodity prices. However, a relaxation of the assumption of time separability will generally destroy these restriction.