Published online by Cambridge University Press: 02 March 2005
We consider an economy with an incomplete securities market and heterogeneously informed investors. Each investor trades in the market to hedge the risk to his endowment and to speculate on future security payoffs using his private information. We examine the efficiency of the securities market in allocating risk and transmitting information under different market structures, as defined by the set of securities traded in the market. We show that the introduction of derivative securities can decrease the market's efficiency in revealing information on security payoffs, and increase the equity premium and price volatility in the market.
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