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Analogy Making, Option Prices, and Implied Volatility

Hammad Siddiqi ()

MPRA Paper from University Library of Munich, Germany

Abstract: We put forward a new option pricing formula based on the notion that people tend to think by analogies and comparisons. The new formula differs from the Black Scholes formula due to the appearance of a parameter in the formula that captures the risk premium on the underlying. The new formula, called the analogy option pricing formula, provides an explanation for the implied volatility skew puzzle in equity options. We also discuss the key empirical predictions of the analogy formula.

Keywords: Analogy Making; Implied Volatility; Implied Volatility Skew; Option Prices; Risk Premium (search for similar items in EconPapers)
JEL-codes: G12 G13 G15 (search for similar items in EconPapers)
Date: 2013-07-01
New Economics Papers: this item is included in nep-rmg
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