Gamma positioning and market quality

Boyd Buis, Mary Pieterse-Bloem, Willem Verschoor and Remco C.J. Zwinkels

Journal of Economic Dynamics and Control, 2024, vol. 164, issue C

Abstract: In this paper, we study the effect of the gamma positioning of dynamic hedgers on market quality through simulations. In our zero-intelligence model, the presence of dynamic hedgers enhances market liquidity under normal conditions. However, positive gamma helps sustain liquidity in stressed scenarios, while negative gamma depletes it. We find that an increase in the net gamma positioning of dynamic hedgers reduces volatility and increases market stability, whereas a negative gamma positioning increases volatility and makes the market more prone to failure. Price discovery typically worsens when dynamic hedgers become more prevalent, regardless of the sign of their positioning. Our findings imply that steering the net gamma position of dynamic hedgers can be considered a policy instrument to improve market quality, especially for instruments with low liquidity or low traded volume.

Keywords: Dynamic hedging; Feedback effect; Market liquidity; Market quality; Simulation (search for similar items in EconPapers)
JEL-codes: C15 C63 D40 G23 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:164:y:2024:i:c:s0165188924000721

DOI: 10.1016/j.jedc.2024.104880

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