Demand-Based Option Pricing

Lasse Pedersen, Nicolae Bogdan Garleanu and ,

No 5420, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We model the demand-pressure effect on prices when options cannot be perfectly hedged. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects contribute to well-known option-pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of both index options and single-stock options.

Keywords: Option; Demand; Valuation; Intermediation; Market makers; Implied volatility; Hedging; Price pressure; Risk; Dealers (search for similar items in EconPapers)
JEL-codes: G0 G12 G13 G14 G2 (search for similar items in EconPapers)
Date: 2005-12
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-mkt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Downloads: (external link)
https://cepr.org/publications/DP5420 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: Demand-Based Option Pricing (2009)
Working Paper: Demand-Based Option Pricing (2005)
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:cpr:ceprdp:5420

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP5420

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().