Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk

Marti G. Subrahmanyam, Günter Franke and Richard C. Stapleton

New York University, Leonard N. Stern School Finance Department Working Paper Seires from New York University, Leonard N. Stern School of Business-

Abstract: In this paper, we derive an equilibrium in which some investors buy call/put options on the market portfolio while others sell them. 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 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.

Date: 1998-02
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Citations: View citations in EconPapers (33)

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Persistent link: https://EconPapers.repec.org/RePEc:fth:nystfi:98-063

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