Anchoring and Adjustment Heuristic in Option Pricing

Hammad Siddiqi

MPRA Paper from University Library of Munich, Germany

Abstract: Based on experimental and anecdotal evidence, an anchoring-adjusted option pricing model is developed in which the volatility of the underlying stock return is used as a starting point that gets adjusted upwards to form expectations about call option volatility. I show that the anchoring price lies within the bounds implied by risk-averse expected utility maximization when there are proportional transaction costs. The anchoring model provides a unified explanation for key option pricing puzzles. Two predictions of the anchoring model are empirically tested and found to be strongly supported with nearly 26 years of options data.

Keywords: Anchoring; Implied Volatility Skew; Covered Call Writing; Zero-Beta Straddle; Leverage Adjusted Option Returns (search for similar items in EconPapers)
JEL-codes: G02 G12 G13 (search for similar items in EconPapers)
Date: 2015-12-30
New Economics Papers: this item is included in nep-cfn and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:68595

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