On the relationship of derivative assets to their underlying instruments
Brown, Sharon J.
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The first essay, "Market Integration and Side by Side Trading of Derivative and Cash Instruments" inquires into the microstructure of integrated trading of derivative and cash instruments and proposes a spatial differentiation model as a framework for analysis. The model illustrates that when broker-dealers can execute cash and derivative transactions proximately they can increase their returns by serving a larger proportion of investors who hold diverse portfolios thereby helping investors to economize on transactions costs. The model predicts that transactions involving a cash and derivative will be effected through an integrated system. The second essay, "Stock Index Futures Trading and Stock Market Volatility," reviews theoretical models and empirical evidence on the relationships between the level of futures trading and volatility. An empirical investigation is conducted by examining the relationship between the daily trading value of the S&P 500 stock index futures contract and the traded value of New York Stock Exchange stocks and considers whether there is higher price volatility in the stock markets when the level of trading in the futures markets is high relative to trading in the cash market. No evidence, theoretical or empirical, is found to support the notion that futures trading leads to greater volatility in the underlying cash market. The third essay, "Liquidation and Delivery Under Conditions of Manipulation models how strategic traders would respond to manipulation given an option to liquidate or deliver on the contract. A perfect Bayesian equilibrium concept is used in which traders must decide whether to liquidate or deliver given the realization of the first period equilibrium futures price. If detected by floor brokers who competitively bid prices to their expected value, the manipulator will cause prices to move against him, raising the equilibrium price when he puts in orders to buy and lowering the price when he seeks to selL Revelation of manipulation through prices also alters the behavior of other traders. An analysis of reactions in a simplified extensive form game indicates that detection of manipulation allows other market participants to stategically adjust their plans regarding liquidation and avoid incurring losses to the manipulator.
- Doctoral Dissertations