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Mispricing of S&P 500 Index Options

Listed author(s):
  • George M. Constantinides
  • Jens Carsten Jackwerth
  • Stylianos Perrakis

Widespread violations of stochastic dominance by 1-month S&P 500 index call options over 1986--2006 imply that a trader can improve expected utility by engaging in a zero-net-cost trade net of transaction costs and bid-ask spread. Although precrash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data. Substantial violations by postcrash OTM calls contradict the notion that the problem lies primarily with the left-hand tail of the index return distribution and that the smile is too steep. The decrease in violations over the postcrash period of 1988--1995 is followed by a substantial increase over 1997--2006, which may be due to the lower quality of the data but, in any case, does not provide evidence that the options market is becoming more rational over time. The Author 2008. Published by Oxford University Press on behalf of the Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhn009
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Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 22 (2009)
Issue (Month): 3 (March)
Pages: 1247-1277

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Handle: RePEc:oup:rfinst:v:22:y:2009:i:3:p:1247-1277
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  1. George M. Constantinides & Thaleia Zariphopoulou, 2001. "Bounds on Derivative Prices in an Intertemporal Setting with Proportional Transaction Costs and Multiple Securities," Mathematical Finance, Wiley Blackwell, vol. 11(3), pages 331-346.
  2. Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2005. "Can Standard Preferences Explain the Prices of out of the Money S&P 500 Put Options," NBER Working Papers 11861, National Bureau of Economic Research, Inc.
  3. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
  4. Pedro Santa-Clara & Shu Yan, 2004. "Jump and Volatility Risk and Risk Premia: A New Model and Lessons from S&P 500 Options," NBER Working Papers 10912, National Bureau of Economic Research, Inc.
  5. Garcia, Rene & Luger, Richard & Renault, Eric, 2003. "Empirical assessment of an intertemporal option pricing model with latent variables," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 49-83.
  6. Perrakis, Stylianos, 1986. "Option Bounds in Discrete Time: Extensions and the Pricing of the American Put," The Journal of Business, University of Chicago Press, vol. 59(1), pages 119-141, January.
  7. Yacine Aït-Sahalia & Andrew W. Lo, 1998. "Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices," Journal of Finance, American Finance Association, vol. 53(2), pages 499-547, 04.
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  9. Jens Carsten Jackwerth., 1996. "Recovering Risk Aversion from Option Prices and Realized Returns," Research Program in Finance Working Papers RPF-265, University of California at Berkeley.
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  11. Peter Ryan, 2000. "Tighter Option Bounds from Multiple Exercise Prices," Review of Derivatives Research, Springer, vol. 4(2), pages 155-188, May.
  12. Hayne E. Leland., 1984. "Option Pricing and Replication with Transactions Costs," Research Program in Finance Working Papers 144, University of California at Berkeley.
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  15. Robert R. Bliss & Nikolaos Panigirtzoglou, 2004. "Option-Implied Risk Aversion Estimates," Journal of Finance, American Finance Association, vol. 59(1), pages 407-446, 02.
  16. Levy, Haim, 1985. " Upper and Lower Bounds of Put and Call Option Value: Stochastic Dominance Approach," Journal of Finance, American Finance Association, vol. 40(4), pages 1197-1217, September.
  17. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-1632, December.
  18. Ryan, Peter J., 2003. "Progressive option bounds from the sequence of concurrently expiring options," European Journal of Operational Research, Elsevier, vol. 151(1), pages 193-223, November.
  19. Ait-Sahalia, Yacine & Duarte, Jefferson, 2003. "Nonparametric option pricing under shape restrictions," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 9-47.
  20. (*), Thaleia Zariphopoulou & George M. Constantinides, 1999. "Bounds on prices of contingent claims in an intertemporal economy with proportional transaction costs and general preferences," Finance and Stochastics, Springer, vol. 3(3), pages 345-369.
  21. Perrakis, Stylianos & Ryan, Peter J, 1984. " Option Pricing Bounds in Discrete Time," Journal of Finance, American Finance Association, vol. 39(2), pages 519-525, June.
  22. George M. Constantinides, 1979. "Multiperiod Consumption and Investment Behavior with Convex Transactions Costs," Management Science, INFORMS, vol. 25(11), pages 1127-1137, November.
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