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Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment

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  • Siddiqi, Hammad

Abstract

Mullainathan et al [Quarterly Journal of Economics, May 2008] present a model of coarse thinking or analogy based thinking. The essential idea behind coarse thinking is that people put situations into categories and the values assigned to attributes in a given situation are affected by the values of corresponding attributes in other co-categorized situations. We test this hypothesis in an experiment on financial options against the benchmark of arbitrage-free pricing. Firstly, we test whether a financial option is priced in analogy with its underlying stock (transference). Secondly, we test for whether variations in the analogy between a financial option and its underlying stock matter (framing). We find evidence in support of both transference and framing.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13515.

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Date of creation: 19 Feb 2009
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Handle: RePEc:pra:mprapa:13515

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Keywords: Coarse Thinking; Financial Options; Arbitrage-Free Pricing;

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References

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  1. Shleifer, Andrei & Mullainathan, Sendhil & Schwartzstein, Joshua, 2008. "Coarse Thinking and Persuasion," Scholarly Articles 11022284, Harvard University Department of Economics.
  2. Linda Babcock & George Loewenstein, 1997. "Explaining Bargaining Impasse: The Role of Self-Serving Biases," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 109-126, Winter.
  3. Rockenbach, Bettina, 2004. "The behavioral relevance of mental accounting for the pricing of financial options," Journal of Economic Behavior & Organization, Elsevier, vol. 53(4), pages 513-527, April.
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Cited by:
  1. Siddiqi, Hammad, 2011. "Thinking by analogy, systematic risk, and option prices," MPRA Paper 31316, University Library of Munich, Germany.
  2. Siddiqi, Hammad, 2010. "Coarse thinking, implied volatility, and the valuation of call and put options," MPRA Paper 23261, University Library of Munich, Germany.

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