Spanning with American options. (Q1399554)

The author considers American options that expire at the terminal date and are available for trade at all dates. They are referred to as multiperiod American options. It is proved that if a primitive security separates states at the terminal date, then generically there exist multiperiod American options on that security generating dynamically complete markets under the optimal exercise policies. It is shown that when the primitive securities and the multiperiod American options are available for trade, there is a security markets equilibrium with two important properties. First, the security market equilibrium allocation coincides with an Arrow-Debreu equilibrium allocation and is therefore Pareto optimal. Second, all agents use the same exercise policy for each of the multiperiod American options available for trade. The second result concerns the existence of multidate economies in which multiperiod American options generate dynamically complete markets under the optimal exercise policy, while multiperiod European options do not. The example of a three-date economy with a single primitive security is presented and it is established that in this case markets are not dynamically complete even if all multiperiod European options on the primitive security are available for trade. In contrast, multiperiod American options on that security generate dynamically complete markets under the optimal exercise policy. An example of an economy, in which the minimum number of multiperiod European options generating dynamically complete market is lower than the one for multiperiod American options, is also provided.