Price Discovery for Derivatives

26 Feb 2023  ·  Christian Keller, Michael C. Tseng ·

We consider price discovery across derivative markets in a general framework where an agent has private information regarding state probabilities and trades state-contingent claims. In an equivalent options formulation, the informed agent has private information regarding arbitrary aspects of an underlying asset's payoff distribution and trades option portfolios. We characterize the informed demand, price impact, and information efficiency of prices. The informed demand formula prescribes option strategies for trading on any given aspect of the underlying payoff, thereby rationalizing and extending those used in practice for e.g. volatility trading.

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