Anchoring Heuristic in Option Prices

Hammad Siddiqi

MPRA Paper from University Library of Munich, Germany

Abstract: An anchoring-adjusted option pricing model is developed in which the expected return of the underlying stock is used as a starting point that gets adjusted upwards to form expectations about corresponding call option returns. Anchoring bias implies that such adjustments are insufficient. In continuous time, the anchoring price always lies within the bounds implied by expected utility maximization when there are proportional transaction costs. Hence, an expected utility maximizer may not gain utility by trading against the anchoring prone investors. The anchoring model is consistent with key features in option prices such as implied volatility skew, superior historical performance of covered call writing, inferior performance of zero-beta straddles, smaller than expected call option returns, and large magnitude negative put returns. The model is also consistent with the puzzling patterns in leverage adjusted option returns, and extends easily to jump-diffusion and stochastic-volatility approaches.

Keywords: Option Pricing; Implied Volatility; Anchoring Bias; Option Pricing Puzzles (search for similar items in EconPapers)
JEL-codes: G02 G13 (search for similar items in EconPapers)
Date: 2014-01-10, Revised 2015-07-15
New Economics Papers: this item is included in nep-upt
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