IDEAS home Printed from https://ideas.repec.org/a/spr/decfin/v43y2020i1d10.1007_s10203-019-00244-z.html
   My bibliography  Save this article

A note on Stein’s overreaction puzzle

Author

Listed:
  • Yuehao Lin

    (University of Luxembourg)

  • Thorsten Lehnert

    (University of Luxembourg)

Abstract

Recently, Christoffersen et al. (Rev Financ Stud 26(8):1963–2006, 2013) argue that the overreaction puzzle of Stein (J Finance 44(4):1011–1023, 1989) can be explained by a variance-dependent pricing kernel. In this note, we challenge this view. Our theoretical results are in line with their argument that the variance under risk-neutral measure is more persistent than the variance under physical measure due to a negative variance risk premium. But our results do not support their argument that the more persistent variance is able to qualitatively explain Stein’s findings. We show theoretically that the persistence of the volatility cannot amplify the movements of long-term variance to short-term fluctuations in variance and, therefore, conclude that Stein’s overreaction puzzle is still unsolved.

Suggested Citation

  • Yuehao Lin & Thorsten Lehnert, 2020. "A note on Stein’s overreaction puzzle," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 43(1), pages 269-276, June.
    • Handle: RePEc:spr:decfin:v:43:y:2020:i:1:d:10.1007_s10203-019-00244-z
    DOI: 10.1007/s10203-019-00244-z
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s10203-019-00244-z
    File Function: Abstract
    Download Restriction: Access to the full text of the articles in this series is restricted.
    File URL: https://libkey.io/10.1007/s10203-019-00244-z?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to

    for a different version of it.

    References listed on IDEAS

    as
    1. Peter Christoffersen & Steven Heston & Kris Jacobs, 2013. "Capturing Option Anomalies with a Variance-Dependent Pricing Kernel," The Review of Financial Studies, Society for Financial Studies, vol. 26(8), pages 1963-2006.
    2. Brennan, M J, 1979. "The Pricing of Contingent Claims in Discrete Time Models," Journal of Finance, American Finance Association, vol. 34(1), pages 53-68, March.
    3. Allen M. Poteshman, 2001. "Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market," Journal of Finance, American Finance Association, vol. 56(3), pages 851-876, June.
    4. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
    5. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
    6. Thorsten Lehnert & Yuehao Lin & Nicolas Martelin, 2013. "Stein s Overreaction Puzzle: Option Anomaly or Perfectly Rational Behavior?," LSF Research Working Paper Series 13-11, Luxembourg School of Finance, University of Luxembourg.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Christoffersen, Peter & Heston, Steven & Jacobs, Kris, 2010. "Option Anomalies and the Pricing Kernel," Working Papers 11-17, University of Pennsylvania, Wharton School, Weiss Center.
    2. Kadir G. Babaoglou & Peter Christoffersen & Steven L. Heston & Kris Jacobs, 2014. "Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels," CREATES Research Papers 2015-55, Department of Economics and Business Economics, Aarhus University.
    3. Hsuan‐Ling Chang & Yen‐Cheng Chang & Hung‐Wen Cheng & Po‐Hsiang Peng & Kevin Tseng, 2019. "Jump variance risk: Evidence from option valuation and stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(7), pages 890-915, July.
    4. Steven Heston & Kris Jacobs & Hyung Joo Kim, 2023. "The Pricing Kernel in Options," Finance and Economics Discussion Series 2023-053, Board of Governors of the Federal Reserve System (U.S.).
    5. Ghanbari, Hamed, 2024. "Persistent and transient variance components in option pricing models with variance-dependent Kernel," Journal of Empirical Finance, Elsevier, vol. 79(C).
    6. René Garcia & Richard Luger & Eric Renault, 2000. "Asymmetric Smiles, Leverage Effects and Structural Parameters," Working Papers 2000-57, Center for Research in Economics and Statistics.
    7. Christoffersen, Peter & Jacobs, Kris & Ornthanalai, Chayawat & Wang, Yintian, 2008. "Option valuation with long-run and short-run volatility components," Journal of Financial Economics, Elsevier, vol. 90(3), pages 272-297, December.
    8. Tak Siu, 2006. "Option Pricing Under Autoregressive Random Variance Models," North American Actuarial Journal, Taylor & Francis Journals, vol. 10(2), pages 62-75.
    9. Kevin Aretz & Ming-Tsung Lin & Ser-Huang Poon, 2023. "Moneyness, Underlying Asset Volatility, and the Cross-Section of Option Returns," Review of Finance, European Finance Association, vol. 27(1), pages 289-323.
    10. David S. Bates, 1995. "Testing Option Pricing Models," NBER Working Papers 5129, National Bureau of Economic Research, Inc.
    11. Luiz Vitiello & Ser-Huang Poon, 2014. "Non-monotonic pricing kernel and an extended class of mixture of distributions for option pricing," Review of Derivatives Research, Springer, vol. 17(2), pages 241-259, July.
    12. Pratish Patel & Andrew Raquel & Savannah Chadwick, 2024. "The cash-secured put-write strategy and the variance risk premium," Journal of Asset Management, Palgrave Macmillan, vol. 25(1), pages 31-50, February.
    13. Christoffersen, Peter & Heston, Steve & Jacobs, Kris, 2006. "Option valuation with conditional skewness," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 253-284.
    14. Peter Christoffersen & Kris Jacobs, 2002. "Which Volatility Model for Option Valuation?," CIRANO Working Papers 2002s-33, CIRANO.
    15. René Garcia & Richard Luger & Eric Renault, 2001. "Empirical Assessment of an Intertemporal Option Pricing Model with Latent Variables (Note : Nouvelle version Février 2002)," CIRANO Working Papers 2001s-02, CIRANO.
    16. Nicolae Garleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2009. "Demand-Based Option Pricing," The Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4259-4299, October.
    17. Thorsten Lehnert & Yuehao Lin & Nicolas Martelin, 2013. "Stein s Overreaction Puzzle: Option Anomaly or Perfectly Rational Behavior?," LSF Research Working Paper Series 13-11, Luxembourg School of Finance, University of Luxembourg.
    18. Dietmar P. J. Leisen, 2018. "Heterogeneity In Risk Preferences Leads To Stochastic Volatility," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(06), pages 1-27, September.
    19. 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.
    20. Simon Scheidegger & Adrien Treccani, 2021. "Pricing American Options under High-Dimensional Models with Recursive Adaptive Sparse Expectations [Telling from Discrete Data Whether the Underlying Continuous-Time Model Is a Diffusion]," Journal of Financial Econometrics, Oxford University Press, vol. 19(2), pages 258-290.

    More about this item

    Keywords

    ;
    ;
    ;
    ;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:decfin:v:43:y:2020:i:1:d:10.1007_s10203-019-00244-z. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.