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Market Power And Feedback Effects From Hedging Derivatives

Author

Listed:
  • 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)

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.

Suggested Citation

  • João Amaro De Matos & João Sobral Do Rosário, 2002. "Market Power And Feedback Effects From Hedging Derivatives," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 5(08), pages 845-875.
    • Handle: RePEc:wsi:ijtafx:v:05:y:2002:i:08:n:s0219024902001766
    DOI: 10.1142/S0219024902001766
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    References listed on IDEAS

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