Implications of an index-contingent trading mechanism

This article analyzes a call market that enables conditioning not only on an asset price but also on an index (a weighted average of stock prices) that is determined simultaneously with the prices of all assets. We compare two trading systems, with and without index conditioning, and find that in the sytem with index conditioning (i) traders indeed use the facility of index conditioning, (ii) there is more "depth" (liquidity) in the market, (iii) price fluctuations around "true" values are lower, (iv) expected trading costs of liquidity traders are lower, and (v) the expected utility of informed traders is lower than in a system without index conditioning.