Analysis of the Interaction between Option Market and Its Underlying Market by Coupled Artificial Markets

Abstract

SummaryThe effect of option markets on their underlying markets has been studied intensively since the first option market launched. Despite considerable efforts, including the development of theoretical and empirical approaches, we do not yet have conclusive evidence on this effect. We investigate the effect of option markets, especially that of dynamic hedging, on their underlying markets by using an artificial market. We propose a two-market model in which an option market and its underlying market interact. We confirmed that trading behaviors on expire date are not effect on its underlying market, but dynamic hedging, arbitrage trading changed volatility on the price of underlying asset under certain conditions.