Nothing Special   »   [go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/23261.html
   My bibliography  Save this paper

Coarse thinking, implied volatility, and the valuation of call and put options

Author

Listed:
  • Siddiqi, Hammad
Abstract
People think by analogies and comparisons. Such way of thinking, termed coarse thinking by Mullainathan et al [Quarterly Journal of Economics, May 2008] is intuitively very appealing. We derive a new option pricing formula based on the assumption that the market consists of coarse thinkers as well as rational investors. The new formula, called the behavioral option pricing formula is a generalization of the Black-Scholes formula. The new formula not only provides explanations for the implied volatility skew and term structure puzzles in equity index options but is also consistent with the observed negative relationship between contemporaneous equity price shocks and implied volatility.

Suggested Citation

  • Siddiqi, Hammad, 2010. "Coarse thinking, implied volatility, and the valuation of call and put options," MPRA Paper 23261, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:23261
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/23261/1/MPRA_paper_23261.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Peter Bossaerts & Charles Plott, 2004. "Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets," Review of Finance, European Finance Association, vol. 8(2), pages 135-169.
    2. Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2008. "Coarse Thinking and Persuasion," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(2), pages 577-619.
    3. repec:bla:jfinan:v:59:y:2004:i:3:p:969-998 is not listed on IDEAS
    4. Rockenbach, Bettina, 2004. "The behavioral relevance of mental accounting for the pricing of financial options," Journal of Economic Behavior & Organization, Elsevier, vol. 53(4), pages 513-527, April.
    5. Linda Babcock & Xianghong Wang & George Loewenstein, 1996. "Choosing the Wrong Pond: Social Comparisons in Negotiations That Reflect a Self-Serving Bias," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 111(1), pages 1-19.
    6. Siddiqi, Hammad, 2009. "Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment," MPRA Paper 13515, University Library of Munich, Germany.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Siddiqi, Hammad, 2013. "Analogy Making, Option Prices, and Implied Volatility," MPRA Paper 48862, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2013. "Analogy Making in Complete and incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 160608, University of Queensland, School of Economics.
    3. Siddiqi, Hammad, 2014. "Analogy Making and the Puzzles of Index Option Returns and Implied Volatility Skew: Theory and Empirical Evidence," Risk and Sustainable Management Group Working Papers 177302, University of Queensland, School of Economics.
    4. Siddiqi, Hammad, 2013. "Mental Accounting: A Closed-Form Alternative to the Black Scholes Model," MPRA Paper 50759, University Library of Munich, Germany.
    5. Siddiqi, Hammad, 2013. "Analogy Making In Complete and Incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 156934, University of Queensland, School of Economics.
    6. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," MPRA Paper 60921, University Library of Munich, Germany.
    7. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," Risk and Sustainable Management Group Working Papers 187407, University of Queensland, School of Economics.
    8. Siddiqi, Hammad, 2011. "Thinking by analogy, systematic risk, and option prices," MPRA Paper 31316, University Library of Munich, Germany.
    9. Siddiqi, Hammad, 2010. "The relevance of coarse thinking for investors' willingness to pay: An experimental study," MPRA Paper 23924, University Library of Munich, Germany.
    10. Siddiqi, Hammad, 2009. "Coarse Thinking and Pricing a Financial Option," MPRA Paper 21749, University Library of Munich, Germany.
    11. Siddiqi, Hammad, 2009. "Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment," MPRA Paper 13515, University Library of Munich, Germany.
    12. Siddiqi, Hammad, 2015. "Analogy based Valuation of Commodity Options," MPRA Paper 61083, University Library of Munich, Germany.
    13. Siddiqi, Hammad, 2015. "Relative Risk Perception and the Puzzle of Covered Call writing," MPRA Paper 62763, University Library of Munich, Germany.
    14. Siddiqi, Hammad, 2015. "Explaining the Smile in Currency Options: Is it Anchoring?," MPRA Paper 63528, University Library of Munich, Germany.
    15. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," Risk and Sustainable Management Group Working Papers 198776, University of Queensland, School of Economics.
    16. Siddiqi, Hammad, 2012. "The relevance of thinking-by-analogy for investors’ willingness-to-pay: An experimental study," Journal of Economic Psychology, Elsevier, vol. 33(1), pages 19-29.
    17. Siddiqi, Hammad, 2014. "Mental Accounting: A New Behavioral Explanation of Covered Call Performance," Risk and Sustainable Management Group Working Papers 162567, University of Queensland, School of Economics.
    18. Siddiqi, Hammad, 2014. "Anchoring Heuristic in Option Prices," MPRA Paper 66018, University Library of Munich, Germany, revised 15 Jul 2015.
    19. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," MPRA Paper 62333, University Library of Munich, Germany.
    20. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Commodity Options," Risk and Sustainable Management Group Working Papers 197334, University of Queensland, School of Economics.

    More about this item

    Keywords

    Coarse Thinking; Option Pricing; Implied Volatility; Implied Volatility Skew; Implied Volatility Smile; Implied Volatility Term Structure;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:23261. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.