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Anchoring and Adjustment Heuristic in Option Pricing

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  • Siddiqi, Hammad

Abstract

Based on experimental and anecdotal evidence, an anchoring-adjusted option pricing model is developed in which the volatility of the underlying stock return is used as a starting point that gets adjusted upwards to form expectations about call option volatility. I show that the anchoring price lies within the bounds implied by risk-averse expected utility maximization when there are proportional transaction costs. The anchoring model provides a unified explanation for key option pricing puzzles. Two predictions of the anchoring model are empirically tested and found to be strongly supported with nearly 26 years of options data.

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  • Siddiqi, Hammad, 2015. "Anchoring and Adjustment Heuristic in Option Pricing," MPRA Paper 68595, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:68595
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    References listed on IDEAS

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    Cited by:

    1. Siddiqi, Hammad, 2015. "Anchoring and Adjustment Heuristic: A Unified Explanation for Equity Puzzles," MPRA Paper 68729, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2015. "Anchoring Heuristic and the Equity Premium Puzzle," MPRA Paper 68537, University Library of Munich, Germany.

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    More about this item

    Keywords

    Anchoring; Implied Volatility Skew; Covered Call Writing; Zero-Beta Straddle; Leverage Adjusted Option Returns;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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