| This dissertation consists of three essays related to information asymmetries, dynamic trading strategies, and the introduction of derivatives to incomplete financial markets. The first essay is an analysis of how trading frequencies and trading in derivative securities can affect investors' welfare. Hellwig's (1980) model is used to analyze the value of improving trading opportunities by more frequent trading in the underlying asset, or by trading in a derivative asset. With multiple trading sessions, uninformed investors behave as rational trend followers, while more informed investors follow a contrarian strategy. As trading becomes continuous, Pareto efficiency is achieved. With trading in an appropriate derivative security, Pareto efficiency may be achieved in only a single round of trading. All derivative claims are then priced on Black-Scholes principles and, in the absence of further supply shocks, no trading will take place in subsequent trading rounds. The second essay analyzes a model in which information acquisition is endogenized and analyze how the introduction of derivatives affect the incentive to acquire information, which in turn cause the price of the risky asset to increase. The third essay address the informational role of option prices. I show that the price of an option can reveal valuable information to market participants and cause information to be aggregated into prices more rapidly. |
