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Mispricing of S&P 500 Index Options

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Author Info
George M. Constantinides
Jens Carsten Jackwerth
Stylianos Perrakis

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Abstract

Widespread violations of stochastic dominance by 1-month S&P 500 index call options over 1986--2006 imply that a trader can improve expected utility by engaging in a zero-net-cost trade net of transaction costs and bid-ask spread. Although precrash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data. Substantial violations by postcrash OTM calls contradict the notion that the problem lies primarily with the left-hand tail of the index return distribution and that the smile is too steep. The decrease in violations over the postcrash period of 1988--1995 is followed by a substantial increase over 1997--2006, which may be due to the lower quality of the data but, in any case, does not provide evidence that the options market is becoming more rational over time. The Author 2008. Published by Oxford University Press on behalf of the Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhn009
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Publisher Info
Article provided by Oxford University Press for Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 22 (2009)
Issue (Month): 3 (March)
Pages: 1247-1277
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Handle: RePEc:oup:rfinst:v:22:y:2009:i:3:p:1247-1277

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Nicolas P. B. Bollen & Robert E. Whaley, 2004. "Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?," Journal of Finance, American Finance Association, vol. 59(2), pages 711-753, 04. [Downloadable!] (restricted)
  2. Yacine Ait-Sahalia & Andrew W. Lo, 1995. "Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices," NBER Working Papers 5351, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51. [Downloadable!] (restricted)
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  1. Constantinides, George M. & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2007. "Option Pricing: Real and Risk-Neutral Distributions," MPRA Paper 11637, University Library of Munich, Germany. [Downloadable!]
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  2. Nicolae Garleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2005. "Demand-Based Option Pricing," NBER Working Papers 11843, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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This page was last updated on 2009-11-28.

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