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Anchoring Heuristic in Option Pricing

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  • Siddiqi, Hammad
Abstract
An anchoring-adjusted option pricing model is developed in which the expected return of the underlying stock is used as a starting point that gets adjusted upwards to form expectations about corresponding call option returns. Anchoring bias implies that such adjustments are insufficient. In continuous time, the anchoring price always lies within the bounds implied by expected utility maximization when there are proportional transaction costs. Hence, an expected utility maximizer may not gain utility by trading against the anchoring prone investors. The anchoring model is consistent with key features in option prices such as implied volatility skew, superior historical performance of covered call writing, inferior performance of zero-beta straddles, smaller than expected call option returns, and large magnitude negative put returns. The model is also consistent with the puzzling patterns in leverage adjusted option returns, and extends easily to jump-diffusion and stochastic-volatility approaches.

Suggested Citation

  • Siddiqi, Hammad, 2015. "Anchoring Heuristic in Option Pricing," Risk and Sustainable Management Group Working Papers 207677, University of Queensland, School of Economics.
    • Handle: RePEc:ags:uqsers:207677
    DOI: 10.22004/ag.econ.207677
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    References listed on IDEAS

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    Cited by:

    1. Siddiqi, Hammad, 2015. "Anchoring and Adjustment Heuristic: A Unified Explanation for Equity Puzzles," MPRA Paper 68729, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2015. "Anchoring Heuristic and the Equity Premium Puzzle," MPRA Paper 68537, University Library of Munich, Germany.
    3. Hammad, Siddiqi, 2015. "Anchoring Adjusted Capital Asset Pricing Model," MPRA Paper 67403, University Library of Munich, Germany.
    4. Hammad, Siddiqi, 2015. "Index Option Returns from an Anchoring Perspective," MPRA Paper 65331, University Library of Munich, Germany.
    5. Hammad, Siddiqi, 2015. "Capital Asset Pricing Model Adjusted for Anchoring," MPRA Paper 67668, University Library of Munich, Germany.
    6. Siddiqi, Hammad, 2015. "Explaining the Smile in Currency Options: Is it Anchoring?," MPRA Paper 63528, University Library of Munich, Germany.
    7. Siddiqi, Hammad, 2016. "Anchoring and Adjustment Heuristic: A Unified Explanation for Asset-Return Puzzles," Risk and Sustainable Management Group Working Papers 229607, University of Queensland, School of Economics.
    8. Siddiqi, Hammad, 2015. "Anchoring Adjusted Capital Asset Pricing Model," Risk and Sustainable Management Group Working Papers 211224, University of Queensland, School of Economics.

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