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 securities is a simultaneous pricing problem and primary security prices depend on the contractual characteristics of the derivative assets available. In a version of the Mossin mean-variance model we 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.