Autore
Dow, James

Titolo
Arbitrage, hedging, and financial innovation
Periodico
European University Institute of Badia Fiesolana (Fi). Department of Economics - Working papers
Anno: 1996 - Fascicolo: 6 - Pagina iniziale: 1 - Pagina finale: 32

I present a simple model in which it is possible that opening a new market makes everybody worse off. Unlike previous examples in the literature, the analysis does not rely on relative price changes of different consumption goods. This is shown in a standard framework in which uninformed traders with hedging needs interact with risk-averse informed traders, in security markets where prices are set by a competitive market-making system. The paper emphasises cross-market links between hedging and speculative demands: risk-averse arbitrageurs can hedge in the new market to lower the risk of speculative positions in the pre-existing market. This causes a greater incidence of speculative activity in the old market, leading some traders with pure hedging motives in that market to withdraw and reducing liquidity in the old market. The general point argued here is that a risk-averse informed trader who believes an asset to be mispriced will typically be able to reduce the risk of speculating on his belief by hedging with other assets. The availability of such hedging instruments will in turn determine which types of speculative activity are of low risk, and this will influence the strategies to which traders will devote resources.



Testo completo: http://hdl.handle.net/1814/577

Esportazione dati in Refworks (solo per utenti abilitati)