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Psychological Barriers and Option Pricing

Author

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  • Bong‐Gyu Jang
  • Changki Kim
  • Kyeong Tae Kim
  • Seungkyu Lee
  • Dong‐Hoon Shin

Abstract

Psychological barriers are prevalent among various asset classes, and it is important to consider their impact on the prices of derivative securities. This paper demonstrates the potential existence of such barriers on the S&P 500 Index and examines their impact on this index's rate of return and volatility. It focuses on deriving analytic European option prices under the assumption that the dynamics of stock prices follow a threshold model; this paper also evaluates this model's empirical performance relative to the Black–Scholes and constant elasticity of variance (CEV) models. The in‐sample calibration result of the threshold model is found to be superior. Furthermore, it is found that the model provides an efficient hedging method in terms of dollar‐value hedging errors. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark 35:52–74, 2015

Suggested Citation

  • Bong‐Gyu Jang & Changki Kim & Kyeong Tae Kim & Seungkyu Lee & Dong‐Hoon Shin, 2015. "Psychological Barriers and Option Pricing," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 35(1), pages 52-74, January.
    • Handle: RePEc:wly:jfutmk:v:35:y:2015:i:1:p:52-74
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    Cited by:

    1. Li, Dan & Liu, Lixin & Xu, Guangli, 2023. "Psychological barriers and option pricing in a local volatility model," The North American Journal of Economics and Finance, Elsevier, vol. 64(C).
    2. Antoine Lejay & Paolo Pigato, 2017. "A threshold model for local volatility: evidence of leverage and mean reversion effects on historical data," Working Papers hal-01669082, HAL.
    3. Shiyu Song & Yongjin Wang, 2017. "Pricing double barrier options under a volatility regime-switching model with psychological barriers," Review of Derivatives Research, Springer, vol. 20(3), pages 255-280, October.
    4. Antoine Lejay & Paolo Pigato, 2019. "A Threshold Model For Local Volatility: Evidence Of Leverage And Mean Reversion Effects On Historical Data," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(04), pages 1-24, June.
    5. Júlio Lobão & Natércia Fortuna & Franklin Silva, 2020. "Do psychological barriers exist in Latin American stock markets?," Revista de Analisis Economico – Economic Analysis Review, Universidad Alberto Hurtado/School of Economics and Business, vol. 35(2), pages 29-56, October.

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