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Anchoring Heuristic in Option Pricing

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  • Siddiqi, Hammad

Abstract

An anchoring adjusted option pricing model is put forward in which the risk of the underlying stock is used as a starting point that gets adjusted upwards to estimate call option risk. Anchoring bias implies that such adjustments are insufficient. Black-Scholes formula is a special case with no anchoring bias. The new model provides a unified explanation for a number of option pricing puzzles including the implied volatility skew, superior historical performance of covered call writing, and worse-than-expected performance of zero beta straddles. The model is also consistent with recent empirical findings regarding leverage adjusted option returns. Anchoring adjusted jump diffusion and stochastic volatility models are also put forward.

Suggested Citation

  • Siddiqi, Hammad, 2015. "Anchoring Heuristic in Option Pricing," MPRA Paper 63218, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:63218
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    Cited by:

    1. Siddiqi, Hammad, 2015. "Anchoring and Adjustment Heuristic: A Unified Explanation for Equity Puzzles," MPRA Paper 68729, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2015. "Anchoring Heuristic and the Equity Premium Puzzle," MPRA Paper 68537, University Library of Munich, Germany.
    3. Hammad, Siddiqi, 2015. "Anchoring Adjusted Capital Asset Pricing Model," MPRA Paper 67403, University Library of Munich, Germany.
    4. Hammad, Siddiqi, 2015. "Index Option Returns from an Anchoring Perspective," MPRA Paper 65331, University Library of Munich, Germany.
    5. Hammad, Siddiqi, 2015. "Capital Asset Pricing Model Adjusted for Anchoring," MPRA Paper 67668, University Library of Munich, Germany.
    6. Siddiqi, Hammad, 2015. "Explaining the Smile in Currency Options: Is it Anchoring?," MPRA Paper 63528, University Library of Munich, Germany.
    7. Siddiqi, Hammad, 2016. "Anchoring and Adjustment Heuristic: A Unified Explanation for Asset-Return Puzzles," Risk and Sustainable Management Group Working Papers 229607, University of Queensland, School of Economics.
    8. Siddiqi, Hammad, 2015. "Anchoring Adjusted Capital Asset Pricing Model," Risk and Sustainable Management Group Working Papers 211224, University of Queensland, School of Economics.

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    More about this item

    Keywords

    Anchoring; Option Pricing; Behavioral Finance; Implied Volatility; Option Pricing Puzzles;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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