In this paper, we study the effect of gamma positioning of dynamic hedgers on market quality through simulations. We find that increases in the net gamma positioning of dynamic hedgers reduces volatility and increases market stability, whereas a negative gamma positioning increases volatility and makes the market more prone to fail. Price discovery typically worsens when dynamic hedgers become more prevalent, regardless of the sign of their positioning. Our findings imply that gearing the gravity of gamma among dynamic hedgers can be considered a policy instrument to improve market quality, especially for instruments with low liquidity and low traded volume.
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|Published - 13 May 2022