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Risk Aversion, Intertemporal Substitution, and Option Pricing

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  • René Garcia
  • Eric Renault

Abstract

This paper develops a general stochastic framework and an equilibrium asset pricing model theat make clear how attitudes towards intertemporal substitution and risk matter for option pricing; In particular we show under which statistical conditions option princing formulas are not preference-free, in other words when preferences are not hidden in the stock and bond prices as they are in the standard Black and Scholes (BS) or Hull and White (HW) pricing formulas.
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  • René Garcia & Eric Renault, 1998. "Risk Aversion, Intertemporal Substitution, and Option Pricing," CIRANO Working Papers 98s-02, CIRANO.
  • Handle: RePEc:cir:cirwor:98s-02
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    Cited by:

    1. 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.
    2. 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.
    3. Stanislav Khrapov, 2012. "Risk Premia: Short and Long-term," Working Papers w0169, New Economic School (NES).
    4. H. Bertholon & A. Monfort & F. Pegoraro, 2008. "Econometric Asset Pricing Modelling," Journal of Financial Econometrics, Oxford University Press, vol. 6(4), pages 407-458, Fall.
    5. Jacquier, Eric & Jarrow, Robert, 2000. "Bayesian analysis of contingent claim model error," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 145-180.
    6. Henri Bertholon & Alain Monfort & Fulvio Pegoraro, 2006. "Pricing and Inference with Mixtures of Conditionally Normal Processes," Working Papers 2006-28, Center for Research in Economics and Statistics.
    7. Eric Ghysels & Valentin Patilea & Eric Renault & Olivier Torrès, 1997. "Nonparametric Methods and Option Pricing," CIRANO Working Papers 97s-19, CIRANO.
    8. René Garcia & Eric Ghysels & Eric Renault, 2004. "The Econometrics of Option Pricing," CIRANO Working Papers 2004s-04, CIRANO.
    9. Fengler, Matthias R. & Hin, Lin-Yee, 2015. "Semi-nonparametric estimation of the call-option price surface under strike and time-to-expiry no-arbitrage constraints," Journal of Econometrics, Elsevier, vol. 184(2), pages 242-261.
    10. Robert R. Bliss & Nikolaos Panigirtzoglou, 2001. "Recovering risk aversion from options," Working Paper Series WP-01-15, Federal Reserve Bank of Chicago.
    11. Garcia, Rene & Gencay, Ramazan, 2000. "Pricing and hedging derivative securities with neural networks and a homogeneity hint," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 93-115.
    12. 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.

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    More about this item

    Keywords

    Causality; hidden Markov chains; non-separable utility; equilibrium option pricing; recursive utility; Black-Scholes implicit volatility; smile effect; Causalité; chaînes de Markov cachées; utilité non séparable; évaluation d.options par modèle d'équilibre; utilité récursive; volatilité implicite de Black-Scholes; sourire de volatilité;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G1 - Financial Economics - - General Financial Markets

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