This paper examines the formation of option transaction prices in an imperfect market where risk-averse dealers face liquidity and informed traders. Because of market imperfections, trading is costly and arbitrage pricing does not apply. Rather, the transaction prices are related to the dealers'...

Dealers are suppliers of liquidity; in this respect their role is similar to that played by speculators in auction markets. However, dealers are a special kind of speculator, because of the many obligations and privileges conferred upon them. The most obvious constraint on dealers' behaviour is...