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Mispricing of Index Options with Respect to Stochastic Dominance Bounds? A Reply

Author

Listed:
  • Constantinides, George M.
  • Czerwonko, Michal
  • Jackwerth, Jens Carsten
  • Perrakis, Stylianos

Abstract

Constantinides and Perrakis (2002, 2007) derive a lower bound on the price of an option such that an investor increases her utility by buying the option at the ask price if the ask price is lower than the lower bound; and by writing the option at the bid price if the bid price is higher than upper bound. Contrary to the evidence in Constantinides et al. (2009, 2011) who demonstrate several violations of mainly the upper bound on call prices and document a tradable anomaly by exploiting this mispricing, Wallmeier (2020) claims that practically all options on the S&P 500, Eurostoxx 50, and DAX indices lie within the bounds. The main reason for the discrepancy is that Wallmeier erroneously inflates the volatility input to the bounds by about 2% by using the at-the-money implied volatility which is approximately the risk-neutral volatility instead of the physical volatility, as required by the model.

Suggested Citation

  • Constantinides, George M. & Czerwonko, Michal & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2021. "Mispricing of Index Options with Respect to Stochastic Dominance Bounds? A Reply," Critical Finance Review, now publishers, vol. 10(1), pages 57-63, April.
    • Handle: RePEc:now:jnlcfr:104.00000090
    DOI: 10.1561/104.00000090
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    Keywords

    Stochastic dominance; Option pricing bounds; Mispriced options; Mispricing; Options; Index options; S&P 500 index options; Eurostoxx 50 index options; DAX index options;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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