A General Equilibrium Analysis of Option and Stock Market Interactions.

The traditional pricing methodology in finance values derivative securities as redundant assets that have no impact on equilibrium prices and allocations. This paper demonstrates that, when the market is incomplete, primary and derivative asset markets, generically, interact: the valuation of derivative and primary security prices depend on the contractual characteristics of the derivative assets available. In a version of the Mossin mean-variance model, the authors analyze an equilibrium in which a call option (derivative asset) is traded and the equilibrium stock price (primary asset) increases when the options market is opened. Copyright 1991 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Asset Prices in an Exchange Economy with Habit Formation.

This paper analyzes asset prices in a representative agent exchange economy with habit-forming preferences. For a general class of utility indices and endowment processes, the authors characterize the optimal demand for consumption and derive explicit solutions for the interest rate and asset risk premia. They show that consumption smoothness may obtain even when the interest rate is stochastic. The consumption capital asset pricing model may not hold when the endowment process has stochastic coefficients; asset risk premia are larger under mild assumptions. The interest rate depends on the growth in the standard of living. Malliavin calculus is employed in the analysis. Copyright 1991 by The Econometric Society.

The relevance of financial policy

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