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Publication# Equilibrium Models for Derivatives Markets with Frictions

Résumé

This thesis develops equilibrium models, and studies the effects of market frictions on risk-sharing, derivatives pricing, and trading patterns.

In the chapter titled "Imbalance-Based Option Pricing", I develop an equilibrium model of fragmented options markets in which option prices and bid-ask spreads are determined by the nonlinear risk imbalance between dealers and customers. In my model, dealers optimally exploit their market power and charge higher spreads for deep out-of-the-money (OTM) options, leading to an endogenous skew in both prices and spreads. In stark contrast to theories of price pressure in option markets, I show how wealth effects can make customers' net demand for options be negatively correlated with option prices. Under natural conditions, the skewness risk premium is positively correlated with the variance risk premium, consistent with the data.

In the chapter titled "The Demand for Commodity Options", we develop a simple equilibrium model in which commercial hedgers, i.e., producers and consumers, use commodity options and futures to hedge price and quantity risk. We derive an explicit relationship between expected futures returns and the hedgers' demand for out-of-the-money options, and show that the demand for both calls and puts are positively related to expected returns, and the relationship is asymmetric, tilted towards puts. We test and confirm the model predictions empirically using the commitment of traders report from CFTC.

In the chapter titled "Electronic Trading in OTC Markets vs. Centralized Exchange", we model a two-tiered market structure in which an investor can trade an asset on a trading platform with a set of dealers who in turn have access to an interdealer market. The investor's order is informative about the asset's payoff and dealers who were contacted by the investor use this information in the interdealer market. Increasing the number of contacted dealers lowers markups through competition but increases the dealers' costs of providing the asset through information leakage. We then compare a centralized market in which investors can trade among themselves in a central limit order book to a market in which investors have to use the electronic platform to trade the asset. With imperfect competition among dealers, investor welfare is higher in the centralized market if private values are strongly dispersed or if the mass of investors is large.

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Publications associées (2)

Concepts associés (15)

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Plateforme électronique de trading

Dans la finance, une plateforme électronique de trading, est un système informatique permettant de passer des ordres pour des produits financiers via un réseau et grâce à un intermédiaire financier. Différents produits financiers peuvent être négociés sur la plateforme de trading, via un réseau avec un intermédiaire financier ou directement entre les participants ou les membres de la plateforme de trading.

Option

En finance, une option est un produit dérivé qui établit un contrat entre un acheteur et un vendeur. L'acheteur de l'option obtient le droit, et non pas l'obligation, d'acheter (call) ou de vendre (put) un actif sous-jacent à un prix fixé à l'avance (strike), pendant un temps donné ou à une date fixée. Ce contrat peut se faire dans une optique de spéculation sur le prix futur de l'actif sous-jacent, ou d'assurance contre une évolution défavorable de ce prix.

Investisseur

Un investisseur est une personne physique ou morale qui alloue une part de capital disponible dans l'attente d'un retour sur investissement. Il peut ainsi investir dans des actions, des obligations et les droits connexes, des devises, des matières premières, de l'immobilier ou tout autre actif. Un investisseur peut investir sans distinction sur le marché primaire des titres nouvellement émis ou sur le marché secondaire (titres déjà émis), dans des titres de sociétés cotées ou non cotées.

Interest Rate Models

This course gives you an easy introduction to interest rates and related contracts. These include the LIBOR, bonds, forward rate agreements, swaps, interest rate futures, caps, floors, and swaptions.

Launching New Ventures

Develop your promising idea into a successful business concept proposal, and launch it! Gain practical experience in the key steps of the venture creation process, including marketing and fundraising.

Launching New Ventures

Develop your promising idea into a successful business concept proposal, and launch it! Gain practical experience in the key steps of the venture creation process, including marketing and fundraising.

In the first chapter,which is a joint work with Mathieu Cambou and Philippe H.A. Charmoy, we study the distribution of the hedging errors of a European call option for the delta and variance-minimizing strategies. Considering the setting proposed by Heston (1993), we assess the error distribution by computing its moments under the real-world probability measure. It turns out that one is better off implementing either a delta hedging or a variance-minimizing strategy, depending on the strike and maturity of the option under consideration. In the second paper, which is a joint work with Damir Filipovic and Loriano Mancini, we develop a practicable continuous-time dynamic arbitrage-free model for the pricing of European contingent claims. Using the framework introduced by Carmona and Nadtochiy (2011, 2012), the stock price is modeled as a semi-martingale process and, at each time t , the marginal distribution of the European option prices is coded by an auxiliary process that starts at t and follows an exponential additive process. The jump intensity that characterizes these auxiliary processes is then set in motion by means of stochastic dynamics of Itô's type. The model is a modification of the one proposed by Carmona and Nadtochiy, as only finitely many jump sizes are assumed. This crucial assumption implies that the jump intensities are taken values in only a finitedimensional space. In this setup, explicit necessary and sufficient consistency conditions that guarantee the absence of arbitrage are provided. A practicable dynamic model verifying them is proposed and estimated, using options on the S&P 500. Finally, the hedging of variance swap contracts is considered. It is shown that under certain conditions, a variance-minimizing hedging portfolio gives lower hedging errors on average, compared to a model-free hedging strategy. In the third and last chapter, which is a joint work with Rémy Praz, we concentrate on the commodity markets and try to understand the impact of financiers on the hedging decisions. We look at the changes in the spot price, variance, production and hedging choices of both producers and financiers, when the mass of financiers in the economy increases. We develop an equilibrium model of commodity spot and futures markets in which commodity production, consumption, and speculation are endogenously determined. Financiers facilitate hedging by the commodity suppliers. The entry of new financiers thus increases the supply of the commodity and decreases the expected spot prices, to the benefits of the end-users. However, this entry may be detrimental to the producers, as they do not internalize the price reduction due to greater aggregate supply. In the presence of asymmetric information, speculation on the futures market serves as a learning device. The futures price and open interest reveal different pieces of private information regarding the supply and demand side of the spot market, respectively. When the accuracy of private information is low, the entry of new financiers makes both production and spot prices more volatile. The entry of new financiers typically increases the correlation between financial and commodity markets.

This thesis presents new flexible dynamic stochastic models for the evolution of market prices and new methods for the valuation of derivatives. These models and methods build on the recently characterized class of polynomial jump-diffusion processes for which the conditional moments are analytic. The first half of this thesis is concerned with modelling the fluctuations in the volatility of stock prices, and with the valuation of options on the stock. A new stochastic volatility model for which the squared volatility follows a Jacobi process is presented in the first chapter. The stock price volatility is allowed to continuously fluctuate between a lower and an upper bound, and option prices have closed-form series representations when their payoff functions depend on the stock price at finitely many dates. Truncating these series at some finite order entails accurate option price approximations. This method builds on the series expansion of the ratio between the log price density and an auxiliary density, with respect to an orthonormal basis of polynomials in a weighted Lebesgue space. When the payoff functions can be similarly expanded, the method is particularly efficient computationally. In the second chapter, more flexible choices of weighted spaces are studied in order to obtain new series representations for option prices with faster convergence rates. The option price approximation method can then be applied to various stochastic volatility models. The second half of this thesis is concerned with modelling the default times of firms, and with the pricing of credit risk securities. A new class of credit risk models in which the firm default probability is linear in the factors is presented in the third chapter. The prices of defaultable bonds and credit default swaps have explicit linear-rational expressions in the factors. A polynomial model with compact support and bounded default intensities is developed. This property is exploited to approximate credit derivatives prices by interpolating their payoff functions with polynomials. In the fourth chapter, the joint term structure of default probabilities is flexibly modelled using factor copulas. A generic static framework is developed in which the prices of high dimensional and complex credit securities can be efficiently and exactly computed. Dynamic credit risk models with significant default dependence can in turn be constructed by combining polynomial factor copulas and linear credit risk models.