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Impact of Divergent Consumer Confidence on Option Prices

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  • James Huang

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    Abstract

    This paper investigates the impact of divergent consumer confidence on option prices. To model this, we assume that consumers disagree on the expected growth rate of aggregate consumption. With other conditions unchanged in the discrete-time Black–Scholes option-pricing model, we show that the representative consumer will have declining relative risk aversion instead of the assumed constant relative risk aversion. In this case all options will be underpriced by the Black–Scholes model under the assumption of bivariate lognormality. Copyright Kluwer Academic Publishers 2003

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    File URL: http://hdl.handle.net/10.1023/B:REDR.0000004822.47039.bc
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    Bibliographic Info

    Article provided by Springer in its journal Review of Derivatives Research.

    Volume (Year): 6 (2003)
    Issue (Month): 3 (October)
    Pages: 165-177

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    Handle: RePEc:kap:revdev:v:6:y:2003:i:3:p:165-177

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    Web page: http://www.springerlink.com/link.asp?id=102989

    Related research

    Keywords: mispricing of options; consumer confidence; heterogeneous preferences; heterogeneous beliefs; Black–Scholes model;

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    1. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
    2. Brennan, M J, 1979. "The Pricing of Contingent Claims in Discrete Time Models," Journal of Finance, American Finance Association, vol. 34(1), pages 53-68, March.
    3. Franke, Gunter, 1984. " Conditions for Myopic Valuation and Serial Independence of the Market Excess Return in Discrete Time Models," Journal of Finance, American Finance Association, vol. 39(2), pages 425-42, June.
    4. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
    5. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-32, December.
    6. Leland, Hayne E, 1980. " Who Should Buy Portfolio Insurance?," Journal of Finance, American Finance Association, vol. 35(2), pages 581-94, May.
    7. Bailey, Warren & Stulz, René M., 1989. "The Pricing of Stock Index Options in a General Equilibrium Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(01), pages 1-12, March.
    8. Mayshar, Joram, 1983. "On Divergence of Opinion and Imperfections in Capital Markets," American Economic Review, American Economic Association, vol. 73(1), pages 114-28, March.
    9. Bick, Avi, 1987. "On the Consistency of the Black-Scholes Model with a General Equilibrium Framework," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 259-275, September.
    10. Merton, Robert C, 1976. "The Impact on Option Pricing of Specification Error in the Underlying Stock Price Returns," Journal of Finance, American Finance Association, vol. 31(2), pages 333-50, May.
    11. Guenter Franke & Richard C. Stapleton & Marti G. Subrahmanyam, 1999. "When are Options Overpriced? The Black-Scholes Model and Alternative Characterisations of the Pricing Kernel," Finance 9904004, EconWPA.
    12. Guenter Franke & Richard C. Stapleton & Marti G. Subrahmanyam, 1999. "When are Options Overpriced? The Black-Scholes Model and Alternative Characterisations of the Pricing Kernel," CoFE Discussion Paper 99-01, Center of Finance and Econometrics, University of Konstanz.
    13. Canina, Linda & Figlewski, Stephen, 1993. "The Informational Content of Implied Volatility," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 659-81.
    14. Longstaff, Francis A, 1995. "Option Pricing and the Martingale Restriction," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1091-1124.
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    Cited by:
    1. Hara, Chiaki & Huang, James & Kuzmics, Christoph, 2007. "Representative consumer's risk aversion and efficient risk-sharing rules," Journal of Economic Theory, Elsevier, vol. 137(1), pages 652-672, November.

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