BFS 2002

Contributed Talk

Equilibrium Open Interest

Dietmar Leisen, Kenneth Judd

Open interest in a financial contract describes the total number that are held long. This information is quoted at the end of each trading day in addition to price and volume. Our paper investigates the risk-sharing rationale for option demand and the resulting shape of the open interest curve in calls across strikes in an equilibrium setup.We argue that skewness of the terminal stock price distribution drives equilibrium demand in options and that the observed shape of the open interest curve is the result of favorable trade-offs between skewness and variance. We explain that open interest curves are sensitive to the distributional assumptions made for the underlying security; an analysis of open interest in addition to price and volume could therefore enrich current empirical studies.