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Options, Sunspots, and the Creation of Uncertainty

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  • Bowman, David
  • Faust, Jon
Abstract
The authors present two examples in which the addition of an option market leads to sunspot equilibria despite the fact that no sunspot equilibria exist without the market. These examples highlight limitations in two prevalent views of option markets. It is often assumed that option markets help complete otherwise incomplete markets. The authors demonstrate that they can instead increase the number of events agents wish to insure against. As in Fischer Black and Myron Scholes (1973), it is often assumed that option markets are redundant. The authors demonstrate that an option market may not be redundant even when markets were complete before its introduction. Copyright 1997 by the University of Chicago.

Suggested Citation

  • Bowman, David & Faust, Jon, 1997. "Options, Sunspots, and the Creation of Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 957-975, October.
    • Handle: RePEc:ucp:jpolec:v:105:y:1997:i:5:p:957-75
    DOI: 10.1086/262100
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    1. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
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    10. Steinar Ekern & Robert Wilson, 1974. "On the Theory of the Firm in an Economy with Incomplete Markets," Bell Journal of Economics, The RAND Corporation, vol. 5(1), pages 171-180, Spring.
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    Cited by:

    1. François Grand & Xavier Ragot, 2016. "Incomplete markets and derivative assets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(3), pages 517-545, August.
    2. Oehmke, Martin & Zawadowski, Adam, 2015. "Synthetic or real? The equilibrium effects of credit default swaps on bond markets," LSE Research Online Documents on Economics 84511, London School of Economics and Political Science, LSE Library.
    3. Acharya, Sushant & Dogra, Keshav & Singh, Sanjay, 2021. "The Financial Origins of Non-Fundamental Risk," CEPR Discussion Papers 16793, C.E.P.R. Discussion Papers.
    4. Galvani, Valentina & Plourde, André, 2010. "Portfolio diversification in energy markets," Energy Economics, Elsevier, vol. 32(2), pages 257-268, March.
    5. Gunther Capelle-Blancard, 2010. "Are derivatives dangerous?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00605908, HAL.
    6. J. Barkley Rosser, 2001. "Alternative Keynesian and Post Keynesian Perspective on Uncertainty and Expectations," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 23(4), pages 545-566, July.
    7. repec:hal:spmain:info:hdl:2441/1p7ctioc2n80gp0icks5dssdsa is not listed on IDEAS
    8. Le Grand, F. & Ragot, X., 2010. "Prices and volumes of options: A simple theory of risk sharing when markets are incomplete," Working papers 302, Banque de France.
    9. repec:spo:wpmain:info:hdl:2441/1p7ctioc2n80gp0icks5dssdsa is not listed on IDEAS
    10. Galvani, Valentina, 2007. "A note on spanning with options," Mathematical Social Sciences, Elsevier, vol. 54(1), pages 106-114, July.

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