Abstracts

This presentation investigates the impact of imbalanced derivative markets - markets in which not all agents hedge - on the underlying stock market. The availability of a closed-form representation for the equilibrium stock price in the context of a complete (imbalanced) market with terminal consumption allows us to study how this equilibrium outcome is affected by the risk aversion of agents and the degree of imbalance. In particular, it will be shown that the derivatives imbalance leads to significant changes in the equilibrium stock price process: volatility changes from constant to local, while risk premia decrease and become stochastic processes. Moreover the model produces implied volatility skew consistent with empirical observations.