Arrow-Debreu Meets Kyle: Price Discovery Across Derivatives

Christian Keller and Michael C. Tseng

Papers from arXiv.org

Abstract: We analyze price discovery in a model where an agent has arbitrary private information about state probabilities and trades state-contingent claims. Our model integrates the seminal frameworks of Arrow and Debreu (1954) and Kyle (1985). In an equivalent options formulation, the informed agent has arbitrary information about an underlying asset's payoff distribution and trades option portfolios. We characterize the informed demand and information dynamics across markets. Our results offer the first equilibrium-based explanations for longstanding empirical practices and phenomena in option markets, including common trading patterns and the volatility smile across option strikes.

Date: 2023-02, Revised 2025-02
New Economics Papers: this item is included in nep-fmk and nep-mst
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