Mispricing of S&P 500 Index Options

George M. Constantinides, Jens Jackwerth () and Stylianos Perrakis

No 14544, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Widespread violations of stochastic dominance by one-month S&P 500 index call options over 1986-2006 imply that a trader can improve expected utility by engaging in a zero-net-cost trade net of transaction costs and bid-ask spread. Although pre-crash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data. Substantial violations by post-crash OTM calls contradict the notion that the problem primarily lies with the left-hand tail of the index return distribution and that the smile is too steep. The decrease in violations over the post-crash period 1988-1995 is followed by a substantial increase over 1997-2006 which may be due to the lower quality of the data but, in any case, does not provide evidence that the options market is becoming more rational over time.

JEL-codes: G12 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec and nep-fmk
Date: 2008-12
Note: AP
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Related works:
Working Paper: Mispricing of S&P 500 Index Options (2005)
Working Paper: Mispricing of S&P 500 Index Options (2005)
Journal Article: Mispricing of S&P 500 Index Options (2009)
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