The Effect of Derivative Assets on Information Acquisition and Price Behavior in a Rational Expectations Equilibrium

Abstract

This article shows that introducing derivative assets increases incentives to collect information about asset payoffs. The increase in information collection makes the price of the underlying asset more informative and causes the expected price to increase. Extending the model to a dynamic setting with multiple risky assets, we find the introducing derivative assets for one asset increases the expected prices of positively correlated assets and reduces price reaction to future earnings announcements. These findings are consistent with the bulk of the empirical evidence on the relationship between the introduction of derivative assets and the behavior of asset prices.

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