On the Role of Option Applications in Economic Instability

Abstract

The purpose of this chapter is to discuss the potential contribution of the option applications to economic instability. To this end, the chapter briefly reviews the extant literature on financial option pricing and its applications to corporate assets and liabilities. It focuses on the direct relationship between the volatility of the underlying asset and the value of the option. It shows that the theory of option applications by its one-sided emphasis on the value-creating role of volatility promotes excessive risk-taking. Then the chapter discusses how the theory of option applications through the educational system encourages economic agents to make excessively risky decisions. Furthermore, the interactions among these risk-welcoming agents lead to an economic system which becomes increasingly risky. This risky economy, combined with the fact that more than half of the value of the option applications is constituted by the highly volatile value of the options embedded in such applications, translates into wide variations in real investments and the economy.

Citation

Ardalan, K. (2012), "On the Role of Option Applications in Economic Instability", Batten, J.A. and Wagner, N. (Ed.) Derivative Securities Pricing and Modelling (Contemporary Studies in Economic and Financial Analysis, Vol. 94), Emerald Group Publishing Limited, Leeds, pp. 15-46. https://doi.org/10.1108/S1569-3759(2012)0000094004