Pricing of index options in incomplete markets

Caio Almeida and Gustavo Freire

Journal of Financial Economics, 2022, vol. 144, issue 1, 174-205

Abstract: We characterize a set of risk-neutral measures associated with a comprehensive class of risk averse investors. From this set, we show how to construct option price bounds and recover the implied γ: a parameter uniquely identifying the marginal investor pricing a given option. Empirically, we find that S&P 500 option prices are reconciled by heterogeneous marginal investors who differ in their assessment of tail risk. This heterogeneity is time-varying, decreases during financial crises, and provides novel insights into the skew patterns of index options. The recovered investors’ preferences related to compensation for downside risk help predict future market returns.

Keywords: Risk-neutral measure; Option pricing; Incomplete markets; Market segmentation; Return predictability (search for similar items in EconPapers)
JEL-codes: C14 G12 G13 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304405X21002348
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:144:y:2022:i:1:p:174-205

DOI: 10.1016/j.jfineco.2021.05.041

Access Statistics for this article

Journal of Financial Economics is currently edited by G. William Schwert

More articles in Journal of Financial Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().