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Dynamic Equilibrium with Overpriced Put Options

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  • Sergey Isaenko

Abstract

It is a well‐known anomaly that prices of put options are too high when options are out‐of‐the‐money. This paper presents a simple general equilibrium model of the market where European put options become substantially overpriced when they are out‐of‐the‐money. Overpricing is due to the presence of short‐sale constraints on trading stocks and derivatives, as well as the heterogeneity between investors. We confirm the predicting power of the model by comparing its implications with existing empirical results.

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  • Sergey Isaenko, 2007. "Dynamic Equilibrium with Overpriced Put Options," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 36(1), pages 1-26, February.
    • Handle: RePEc:bla:ecnote:v:36:y:2007:i:1:p:1-26
    DOI: 10.1111/j.1468-0300.2007.00177.x
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    References listed on IDEAS

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    1. Jun Pan & Allen M. Poteshman, 2006. "The Information in Option Volume for Future Stock Prices," The Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 871-908.
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    7. Ait-Sahalia, Yacine & Wang, Yubo & Yared, Francis, 2001. "Do option markets correctly price the probabilities of movement of the underlying asset?," Journal of Econometrics, Elsevier, vol. 102(1), pages 67-110, May.
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    Cited by:

    1. Sergei Isaenko, 2008. "On the super-replicating approach when trading a derivative is limited," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 285-297.

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