Two algos, one option: impact of new technology on mispricing and hedging strategies

This thesis contains three studies on the impact of new technologies on financial markets. The first study investigates in an experiment whether algorithmic trading has an impact on the formation of asset price bubbles. It finds that especially market-maker algorithms lead to traded prices being closer to the fundamental values of the asset. The second study looks at whether markets with algorithmic trading can improve the aggregation of information and whether they retain the incentive to acquire that information in the first place. We find that algorithmic traders lead to better pricing if they have good information, but don’t improve prices if they are bad. They impede price discovery through trading due to their high market power combined with their trading logic. Information acquisition behavior of human participants is unchanged between treatments. The last study investigates an investment strategy for retail investors. Put options are purchased to hedge tail-risks and the portfolio is rebalanced according to a simple heuristic. This strategy leads to a reduction of tail-risks at the cost of lower returns. On average, sharpe ratios are slightly improved compared to a buy&hold strategy.