Derivatives Trading in a General Equilibrium Modelwith Stochastic Volatility and Jumps

We perform a general equilibrium analysis in a complete markets economy whenthe dividend follows a jump-diffusion process with stochastic volatility. Agents haveCRRA utility, but differ with respect to their degree of risk aversion. The keyoutput of our analysis is the structure of the investors’ optimal portfolios and thevolume and direction of trading between them. We find that trading in derivatives iseconomically significant, with a value of traded contracts of up to twenty percent oftotal market capitalization. In line with intuition, the less risk-averse investor holdsmore pure stock price risk than the more risk-averse one. Volatility derivatives, onthe other hand, are special in the sense that the direction of trading depends on theexact values for the levels of risk aversion of the individual investors, not just onwho is more and who is less risk-averse.