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Are Options on Index Futures Profitable for Risk Averse Investors? Empirical Evidence

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

Abstract

American options on the S&P 500 index futures that violate the stochastic dominance bounds of Constantinides and Perrakis (2007) from 1983 to 2006 are identified as potentially profitable trades. Call bid prices more frequently violate their upper bound than put bid prices do, while violations of the lower bounds by ask prices are infrequent. In out of sample tests of stochastic dominance, the writing of options that violate the upper bound increases the expected utility of any risk averse investor holding the market and cash, net of transaction costs and bid ask spreads. The results are economically significant and robust.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16302.

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Date of creation: Aug 2010
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Publication status: published as George M. Constantinides & Michal Czerwonko & Jens Carsten Jackwerth & Stylianos Perrakis, 2011. "Are Options on Index Futures Profitable for Risk‐Averse Investors? Empirical Evidence," Journal of Finance, American Finance Association, vol. 66(4), pages 1407-1437, 08.
Handle: RePEc:nbr:nberwo:16302

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  1. Stylianos Perrakis & Jens Carsten Jackwerth & George Constantinides, 2005. "Mispricing of S&P 500 Index Options," Working Papers, Warwick Business School, Finance Group wp05-07, Warwick Business School, Finance Group.
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  9. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, American Finance Association, vol. 49(3), pages 771-818, July.
  10. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, American Finance Association, vol. 51(5), pages 1611-32, December.
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  12. Joost Driessen & Pascal Maenhout, 2007. "An Empirical Portfolio Perspective on Option Pricing Anomalies," Review of Finance, European Finance Association, European Finance Association, vol. 11(4), pages 561-603.
  13. Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(4), pages 842-62, August.
  14. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  15. Eugene Fama & F. & Kenneth R. French, . "The Equity Premium."," CRSP working papers, Center for Research in Security Prices, Graduate School of Business, University of Chicago 522, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  16. Jens Carsten Jackwerth., 1996. "Recovering Risk Aversion from Option Prices and Realized Returns," Research Program in Finance Working Papers, University of California at Berkeley RPF-265, University of California at Berkeley.
  17. George M. Constantinides, 2002. "Rational Asset Prices," NBER Working Papers 8826, National Bureau of Economic Research, Inc.
  18. Constantinides, George M. & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2007. "Option Pricing: Real and Risk-Neutral Distributions," MPRA Paper 11637, University Library of Munich, Germany.
  19. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
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Cited by:
  1. Jens Carsten Jackwerth & George M. Constantinaides & Stylianos Perrakis, 2005. "Option Pricing: Real and Risk-Neutral Distributions," CoFE Discussion Paper, Center of Finance and Econometrics, University of Konstanz 05-06, Center of Finance and Econometrics, University of Konstanz.
  2. Perrakis, Stylianos & Boloorforoosh, Ali, 2013. "Valuing catastrophe derivatives under limited diversification: A stochastic dominance approach," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(8), pages 3157-3168.
  3. George M. Constantinides & Jens Carsten Jackwerth & Alexi Savov, 2012. "The Puzzle of Index Option Returns," Working Paper Series of the Department of Economics, University of Konstanz 2012-35, Department of Economics, University of Konstanz.
  4. Alejandro Balbás & Beatriz Balbás & Raquel Balbás, 2013. "On the inefficiency of Brownian motions and heavier tailed price processes," Business Economics Working Papers id-13-01, Universidad Carlos III, Instituto sobre Desarrollo Empresarial "Carmen Vidal Ballester".
  5. Peter Christoffersen & Mathieu Fournier & Kris Jacobs, 2013. "The Factor Structure in Equity Options," CREATES Research Papers 2013-47, School of Economics and Management, University of Aarhus.

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