Baker, Wayne. 1984. "The Social Structure of a National Securities Market." American Journal of Sociology :775-811.

Networks of options traders on the floor of a major security exchange act in distinct social structure patterns that dramatically affects the option price volatility. Larger networks lead to less communication and higher volatility.

At the exchange, options are traded at a specific location. Two "crowds" of buyers and sellers were selected for network analysis.

In contrast to the ideal market, in real options markets actors have bounded rationality and engage in some opportunistic behavior. Taking orders involves satisficing instead of maximizing. Information is limited on the floor and search costs can be high.

The market in options is very uncertain, and actors will sometimes be restrained, and sometimes opportunistic. Market makers must maintain fair markets and often trade against their own position.

The crowd size on a particular option is dependent on the volatility -- higher volatility means greater chances at profit-making and so more interest. A large crown has more potential relationships than a small crowd. But big crowds generate noise which reduces communication. Actors do not change their trading circles much with crowd size.

There were informal checks against market makers who held back and ignored some demands. In smaller crowds it was easier to spot and sanction opportunism, and so there was less of it.



In a perfect market the actors trading network would be expansive, involving many actors. There would be no restriction of trade. In real networks traders tend to trade with people closer to them (less errors). In response to bounded rationality and opportunism, actors develop restrictive micronetworks and trade with fewer actors and smaller volumes than in the ideal situation.



Ideally an expansive micronetwork should produce an undifferentiated macronetwork. In real networks there is much more differentiation, especially in large crowds, causing larger cliques. While larger crowds should produce more competition, in options crowds the opposite is observed. Based on these views a large market differentiates because large size and growth outstrip the capacity of actors to communicate efficiently.


Price consequences

In ideal markets there should be low variance in market prices of stocks. But in real markets crowd size is a determinant of option price volatility.