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 help explain well-known option-pricing puzzles. First, end users are net long index options, especially out-of-money puts, which helps explain their apparent expensiveness and the smirk. Second, demand patterns help explain the prices of single-stock options.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
11843.
Length: Date of creation: Dec 2005 Date of revision: Handle: RePEc:nbr:nberwo:11843
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Article
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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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.:
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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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