Abstract
Option pricing theory depends on the idea that an option is a redundant asset. Its payoff can be replicated by a dynamic strategy involving just the stock and riskless bonds. This leaves the odd theoretical question of what value there is for options to exist in the first place. In this article, Tan tackles this issue in a simulation of long-term equilibrium in an economy with investors who earn labor income over their lifetimes and have access to a stock index portfolio, riskless bonds but limited ability to borrow, and at-the-money calls and puts on the index. Call options provide considerable utility largely because the leverage they permit allows younger workers with future wage income but little current wealth to increase their exposure to the stock market. Put options, by contrast, add little in the context of this economy.
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