The Influence of Heterogeneous Preferences on Asset Prices in an Incomplete Market Model
In this paper, we examine an exchange economy with a financial market composed of three assets: a share of a stock, an European call option written on the stock, and a riskless bond. The financial market is assumed to be incomplete and the option is not a redundant asset. In such a case the construction of a riskless hedge-portfolio to valuate the option is unfeasible and therefore the pricing of the assets becomes a simultaneous valuation problem, nonlinearly depending on the preferences of the agents. First, the case of homogeneous agents (or, equivalently, of a representative agent) is studied. By means of numerical analysis, it can be found that individual preferences have a major impact on the price relation of the assets, including the price of the option. This stays in contrast to the Black-Scholes analysis, where the option is a redundant asset. A unique price relation exists and no trading takes place. In the case of heterogeneous agents the price relation of the assets crucially depends on the span of heterogeneity of the preferences. Now, trading takes place. The more risk averse agents buy the bond and sell the share and the option, whereas the less risk averse agents buy the option and the share and sell the riskless bond. More surprisingly we find that the representative asset-pricing-model overprices the riskless bond and underprices the option in relation to our model of heterogeneous agents.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||01 Apr 2001|
|Date of revision:|
|Contact details of provider:|| Web page: http://www.econometricsociety.org/conference/SCE2001/SCE2001.html|
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Drees, Burkhard & Eckwert, Bernhard, 1995. " The Risk and Price Volatility of Stock Options in General Equilibrium," Scandinavian Journal of Economics, Wiley Blackwell, vol. 97(3), pages 459-67, September.
- Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September.
- Detemple, Jerome B & Selden, Larry, 1991. "A General Equilibrium Analysis of Option and Stock Market Interactions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(2), pages 279-303, May.
- Bailey, Warren & Stulz, René M., 1989. "The Pricing of Stock Index Options in a General Equilibrium Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(01), pages 1-12, March.
- Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
- Leland, Hayne E, 1980.
" Who Should Buy Portfolio Insurance?,"
Journal of Finance,
American Finance Association, vol. 35(2), pages 581-94, May.
- Brennan, M J, 1979. "The Pricing of Contingent Claims in Discrete Time Models," Journal of Finance, American Finance Association, vol. 34(1), pages 53-68, March.
- Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
- Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
- Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
- Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, June.
- Dietmar P.J. Leisen and Kenneth L. Judd, 2001. "A Partial Equilibrium Model of Option Markets," Computing in Economics and Finance 2001 219, Society for Computational Economics.
- Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
- Guenter Franke & Richard C. Stapleton & Marti G. Subrahmanyam, 1999.
"When are Options Overpriced? The Black-Scholes Model and Alternative Characterisations of the Pricing Kernel,"
CoFE Discussion Paper
99-01, Center of Finance and Econometrics, University of Konstanz.
- Guntar Franke & Richard C. Stapleton & Marti G. Subrahmanyam, 1999. "When are Options Overpriced? The Black-Scholes Model and Alternative Characterizations of the Pricing Kernel," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-003, New York University, Leonard N. Stern School of Business-.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Guenter Franke & Richard C. Stapleton & Marti G. Subrahmanyam, 1999. "When are Options Overpriced? The Black-Scholes Model and Alternative Characterisations of the Pricing Kernel," Finance 9904004, EconWPA.
When requesting a correction, please mention this item's handle: RePEc:sce:scecf1:60. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.