We model the demand-pressure effect on prices when options cannot be perfectly hedged. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects contribute to well-known option-pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of both index options and single-stock options.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
5420.
Nicolae Gârleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2009.
"Demand-Based Option Pricing,"
Review of Financial Studies,
Oxford University Press for Society for Financial Studies, vol. 22(10), pages 4259-4299, October.
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Paper
Nicolae Garleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2005.
"Demand-Based Option Pricing,"
NBER Working Papers
11843, National Bureau of Economic Research, Inc.
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Find related papers by JEL classification: G0 - Financial Economics - - General G12 - Financial Economics - - General Financial Markets - - - Asset Pricing G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies G2 - Financial Economics - - Financial Institutions and Services
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Jens Carsten Jackwerth & George M. Constantinaides & Stylianos Perrakis, 2005.
"Mispricing of S&P 500 Index Options,"
CoFE Discussion Paper
05-09, Center of Finance and Econometrics, University of Konstanz.
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Stylianos Perrakis & Jens Carsten Jackwerth & George Constantinides, 2005.
"Mispricing of S&P 500 Index Options,"
Working Papers
wp05-07, Warwick Business School, Financial Econometrics Research Centre.
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George M. Constantinides & Jens Carsten Jackwerth & Stylianos Perrakis, 2009.
"Mispricing of S&P 500 Index Options,"
Review of Financial Studies,
Oxford University Press for Society for Financial Studies, vol. 22(3), pages 1247-1277, March.
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Shleifer, Andrei & Vishny, Robert W, 1997.
" The Limits of Arbitrage,"
Journal of Finance,
American Finance Association, vol. 52(1), pages 35-55, March.
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