Marti G Subrahmanyam, Günter Franke, Richard C Stapleton
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.
Subrahmanyam: (212) 998-0348 msubrahma@stern.nyu.edu
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