IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/13515.html
   My bibliography  Save this paper

Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment

Author

Listed:
  • Siddiqi, Hammad

Abstract

Mullainathan et al [Quarterly Journal of Economics, May 2008] present a model of coarse thinking or analogy based thinking. The essential idea behind coarse thinking is that people put situations into categories and the values assigned to attributes in a given situation are affected by the values of corresponding attributes in other co-categorized situations. We test this hypothesis in an experiment on financial options against the benchmark of arbitrage-free pricing. Firstly, we test whether a financial option is priced in analogy with its underlying stock (transference). Secondly, we test for whether variations in the analogy between a financial option and its underlying stock matter (framing). We find evidence in support of both transference and framing.

Suggested Citation

  • Siddiqi, Hammad, 2009. "Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment," MPRA Paper 13515, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:13515
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/13515/1/MPRA_paper_13515.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Linda Babcock & George Loewenstein, 1997. "Explaining Bargaining Impasse: The Role of Self-Serving Biases," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 109-126, Winter.
    2. Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2008. "Coarse Thinking and Persuasion," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(2), pages 577-619.
    3. Brian D. Kluger & Steve B. Wyatt, 2004. "Are Judgment Errors Reflected in Market Prices and Allocations? Experimental Evidence Based on the Monty Hall Problem," Journal of Finance, American Finance Association, vol. 59(3), pages 969-998, June.
    4. Rockenbach, Bettina, 2004. "The behavioral relevance of mental accounting for the pricing of financial options," Journal of Economic Behavior & Organization, Elsevier, vol. 53(4), pages 513-527, April.
    5. Linda Babcock & Xianghong Wang & George Loewenstein, 1996. "Choosing the Wrong Pond: Social Comparisons in Negotiations That Reflect a Self-Serving Bias," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 111(1), pages 1-19.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Siddiqi, Hammad, 2013. "Analogy Making in Complete and incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 160608, University of Queensland, School of Economics.
    2. Siddiqi, Hammad, 2014. "The Financial Market Consequences of Growing Awareness: The Case of Implied Volatiltiy Skew," Risk and Sustainable Management Group Working Papers 162568, University of Queensland, School of Economics.
    3. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," MPRA Paper 62333, University Library of Munich, Germany.
    4. Siddiqi, Hammad, 2013. "Analogy Making In Complete and Incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 156934, University of Queensland, School of Economics.
    5. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," Risk and Sustainable Management Group Working Papers 198776, University of Queensland, School of Economics.
    6. Siddiqi, Hammad, 2015. "Relative Risk Perception and the Puzzle of Covered Call Writing," Risk and Sustainable Management Group Working Papers 199882, University of Queensland, School of Economics.
    7. O'Callaghan, Patrick, 2015. "Minimal conditions for parametric continuity of a utility representation," Risk and Sustainable Management Group Working Papers 200371, University of Queensland, School of Economics.
    8. Hammad, Siddiqi, 2015. "Index Option Returns from an Anchoring Perspective," MPRA Paper 65331, University Library of Munich, Germany.
    9. Siddiqi, Hammad, 2014. "Mental Accounting: A New Behavioral Explanation of Covered Call Performance," Risk and Sustainable Management Group Working Papers 162567, University of Queensland, School of Economics.
    10. Siddiqi, Hammad, 2010. "Coarse thinking, implied volatility, and the valuation of call and put options," MPRA Paper 23261, University Library of Munich, Germany.
    11. Siddiqi, Hammad, 2014. "Anchoring Heuristic in Option Prices," MPRA Paper 66018, University Library of Munich, Germany, revised 15 Jul 2015.
    12. Siddiqi, Hammad, 2015. "Relative Risk Perception and the Puzzle of Covered Call writing," MPRA Paper 62763, University Library of Munich, Germany.
    13. Siddiqi, Hammad, 2015. "Explaining the Smile in Currency Options: Is it Anchoring?," MPRA Paper 63528, University Library of Munich, Germany.
    14. Siddiqi, Hammad, 2011. "Thinking by analogy, systematic risk, and option prices," MPRA Paper 31316, University Library of Munich, Germany.
    15. Siddiqi, Hammad, 2015. "Analogy based Valuation of Commodity Options," MPRA Paper 61083, University Library of Munich, Germany.

    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. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," MPRA Paper 60921, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," Risk and Sustainable Management Group Working Papers 187407, University of Queensland, School of Economics.
    3. Siddiqi, Hammad, 2013. "Analogy Making, Option Prices, and Implied Volatility," MPRA Paper 48862, University Library of Munich, Germany.
    4. Siddiqi, Hammad, 2013. "Mental Accounting: A Closed-Form Alternative to the Black Scholes Model," MPRA Paper 50759, University Library of Munich, Germany.
    5. Siddiqi, Hammad, 2009. "Coarse Thinking and Pricing a Financial Option," MPRA Paper 21749, University Library of Munich, Germany.
    6. Siddiqi, Hammad, 2010. "Coarse thinking, implied volatility, and the valuation of call and put options," MPRA Paper 23261, University Library of Munich, Germany.
    7. Siddiqi, Hammad, 2010. "The relevance of coarse thinking for investors' willingness to pay: An experimental study," MPRA Paper 23924, University Library of Munich, Germany.
    8. Siddiqi, Hammad, 2014. "Analogy Making and the Puzzles of Index Option Returns and Implied Volatility Skew: Theory and Empirical Evidence," Risk and Sustainable Management Group Working Papers 177302, University of Queensland, School of Economics.
    9. Siddiqi, Hammad, 2013. "Analogy Making In Complete and Incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 156934, University of Queensland, School of Economics.
    10. Siddiqi, Hammad, 2013. "Analogy Making in Complete and incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 160608, University of Queensland, School of Economics.
    11. Siddiqi, Hammad, 2009. "Is the lure of choice reflected in market prices? Experimental evidence based on the 4-door Monty Hall problem," Journal of Economic Psychology, Elsevier, vol. 30(2), pages 203-215, April.
    12. Siddiqi, Hammad, 2011. "Thinking by analogy, systematic risk, and option prices," MPRA Paper 31316, University Library of Munich, Germany.
    13. Lackner, Mario & Sonnabend, Hendrik, 2021. "Coping with advantageous inequity—Field evidence from professional penalty kicking," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 91(C).
    14. Ubeda, Paloma, 2014. "The consistency of fairness rules: An experimental study," Journal of Economic Psychology, Elsevier, vol. 41(C), pages 88-100.
    15. van der Cruijsen, Carin A.B. & Eijffinger, Sylvester C.W., 2010. "From actual to perceived transparency: The case of the European Central Bank," Journal of Economic Psychology, Elsevier, vol. 31(3), pages 388-399, June.
    16. James Andreoni & Ray D Madoff, 2007. "Overconfdence and Judicial Discretion: Do Winner-take-all Rules Discourage Pre-trial Agreement?," Levine's Bibliography 843644000000000198, UCLA Department of Economics.
    17. Rafael Di Tella & Ricardo Pérez-Truglia, 2010. "Conveniently Upset: Avoiding Altruism by Distorting Beliefs About Others," NBER Working Papers 16645, National Bureau of Economic Research, Inc.
    18. Bejarano, Hernán & Corgnet, Brice & Gómez-Miñambres, Joaquín, 2021. "Economic stability promotes gift-exchange in the workplace," Journal of Economic Behavior & Organization, Elsevier, vol. 187(C), pages 374-398.
    19. Ruud Gerards & Joan Muysken & Riccardo Welters, 2014. "Active Labour Market Policy by a Profit-Maximizing Firm," British Journal of Industrial Relations, London School of Economics, vol. 52(1), pages 136-157, March.
    20. Claudia M. Landeo, 2018. "Law and economics and tort litigation institutions: theory and experiments," Chapters, in: Joshua C. Teitelbaum & Kathryn Zeiler (ed.), Research Handbook on Behavioral Law and Economics, chapter 9, pages 247-268, Edward Elgar Publishing.

    More about this item

    Keywords

    Coarse Thinking; Financial Options; Arbitrage-Free Pricing;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:pra:mprapa:13515. 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: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    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.