Market Volatility and Feedback Effects
نویسندگان
چکیده
In this paper we analyze the manner in which the demand generated by dynamic hedging strategies aaects the equilibrium price of the underlying asset. We derive an explicit expression for the transformation of market volatility under the impact of such strategies. It turns out that volatility increases and becomes time and price dependent. The strength of these eeects however depends not only on the share of total demand that is due to hedging, but also signiicantly on the heterogeneity of the distribution of hedged payoos. We nally discuss in what sense hedging strategies derived from the assumption of constant volatility may still be appropriate even though their implementation obviously violates this assumption.
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