Coarse thinking, implied volatility, and the valuation of call and put options
People think by analogies and comparisons. Such way of thinking, termed coarse thinking by Mullainathan et al [Quarterly Journal of Economics, May 2008] is intuitively very appealing. We derive a new option pricing formula based on the assumption that the market consists of coarse thinkers as well as rational investors. The new formula, called the behavioral option pricing formula is a generalization of the Black-Scholes formula. The new formula not only provides explanations for the implied volatility skew and term structure puzzles in equity index options but is also consistent with the observed negative relationship between contemporaneous equity price shocks and implied volatility.
|Date of creation:||10 Jan 2010|
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- Peter Bossaerts & Charles Plott, 2004.
"Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets,"
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European Finance Association, vol. 8(2), pages 135-169.
- Peter Bossaerts & Charles Plott, 2004. "Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets," Review of Finance, Springer, vol. 8(2), pages 135-169.
- Bossaerts, Peter & Plott, Charles R., 2000. "Basic Principles of Asset Pricing Theory: Evidence From Large-Scale Experimental Financial Markets," Working Papers 1070, California Institute of Technology, Division of the Humanities and Social Sciences.
- Bossaerts, Peter & Plott, Charles, 2000. "Basic Principles Of Asset Pricing Theory: Evidence From Large-Scale Experimental Financial Markets," CEPR Discussion Papers 2578, C.E.P.R. Discussion Papers.
- Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2008.
"Coarse Thinking and Persuasion,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 123(2), pages 577-619.
- Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2006. "Coarse Thinking and Persuasion," NBER Working Papers 12720, National Bureau of Economic Research, Inc.
- Shleifer, Andrei & Mullainathan, Sendhil & Schwartzstein, Joshua, 2008. "Coarse Thinking and Persuasion," Scholarly Articles 11022284, Harvard University Department of Economics.
- 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.
- Siddiqi, Hammad, 2009. "Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment," MPRA Paper 13515, University Library of Munich, Germany. Full references (including those not matched with items on IDEAS)
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