MARKET POWER AND FEEDBACK EFFECTS FROM HEDGING DERIVATIVES

João Amaro de Matos and João Sobral Do Rosário ()
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João Amaro de Matos: Faculdade de Economia, Universidade Nova de Lisboa, Rua Marquês de Fronteira, 20, 1099-038 Lisbon, Portugal
João Sobral Do Rosário: Ecole de Commerce Solvay, Université Libre de Bruxelles, 21, avenue F.D. Roosevelt, 1050 Bruxelles, Belgium

International Journal of Theoretical and Applied Finance (IJTAF), 2002, vol. 05, issue 08, 845-875

Abstract: In this paper we model how the transaction of derivatives affects the price process of the underlying asset, considering the existence of a few agents with market power and a population of liquidity traders. This setting generates an equilibrium bid-ask spread for the underlying asset. The resulting feedback effect of hedging strategies is shown to depend on what type of agent more actively hedges. We also characterize how the feedback effect is lessened as the number of market-makers increases.

Keywords: Bid-ask spread; option pricing; feedback effect; stochastic volatility (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1142/S0219024902001766

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