Estimation Risk and Adaptive Behavior in the Pricing of Options
AbstractWe consider the effects of uncertainty in the statistical parameters of the Gaussian process in the context of the Black-Scholes option pricing model. With continuous time observation of returns, uncertainty about the variance disappears over any finite time interval, but uncertainty about the mean diminishes at the rate of 1/" tau", where "tau" is the length of the time interval of observation. In a market in which participants base their portfolio decisions on the predictive distribution of returns, option prices will be higher than in a market in which uncertainty in the mean is ignored. Even though the mean parameter, "mu," is itself irrelevant in the Black-Scholes model, uncertainty about "mu" affects option values under our behavioral assumptions. Copyright 1991 by MIT Press.
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Bibliographic InfoArticle provided by Eastern Finance Association in its journal The Financial Review.
Volume (Year): 26 (1991)
Issue (Month): 1 (February)
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- Lo, Andrew W & Wang, Jiang, 1995.
" Implementing Option Pricing Models When Asset Returns Are Predictable,"
Journal of Finance,
American Finance Association, vol. 50(1), pages 87-129, March.
- Lo, Andrew W. (Andrew Wen-Chuan) & Wang, Jiang, 1959-, 1993. "Implementing option pricing models when asset returns are predictable," Working papers 3593-93., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Andrew W. Lo & Jiang Wang, 1994. "Implementing Option Pricing Models When Asset Returns Are Predictable," NBER Working Papers 4720, National Bureau of Economic Research, Inc.
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