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An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies

1988; University of Chicago Press; Volume: 61; Issue: 3 Linguagem: Inglês

10.1086/296433

1537-5374

Sanford J. Grossman,

Market Dynamics and Volatility

Recent àdvancès tn financiat theory hive created an understanding, of the 'énv1ronmentsin which .a real security cant be synthesized by'I dynamic trading H... •'.strategy in a risk free asset and other securities.We contend.that there is a'crucial distinction between a lynthetic security and a real security.In particular the notion that a real security is redundant when it' can be synthesized by a 'dynamic trAding 'strategy Ignores" the: infoirmati onal role of rSal "securities markets.'The replacement of a real security by synthetic strategies may.in' itself cause enough uncertainty"about the priëe volatility of the' underlying secUrity, that the real security is no longer redundant.Portfol to iniurance provides, a 'good.éxanqle of 'the 'difference between a synthetic security and a real security.One fonn. of portfolio insurance uses a trading strategy in risk' free *ecuritià"(Mcash"), arid Index futures to synthesize ...a'Eui'opean put on the underlying'portfolio.' In 'the 'Abténce 'of a real,'traded ptitoptidn (of the appropriate striking p'riàe, and maturity) there 1111 be less 'tnlonnation ibout the future price volatility associated with current dynamic hedging strategies.There will thus be less information transmitted to those people who could make capital available to liquidity providers.It will therefore be more difficult for the market to absorb the trades implied by the dynannc hedging strategies.In-effect, 'the stockil..