Patterns in the Payoffs of Structured Equity Derivatives
51 Pages Posted: 20 Mar 2007 Last revised: 13 Dec 2007
Date Written: October 2007
Abstract
Structured equity products (SEP's) are medium-term notes with payoffs based on the prices of common stocks, baskets of stocks, or stock indices. This paper documents striking patterns in the payoff profiles of SEPs. Products based on the prices of individual equities predominantly have concave payoff profiles, while those based on equity indices predominantly have convex payoffs. Given SEP markups, it seems unlikely that these patterns can be explained by any plausible normative model of the behavior of rational investors. Thus, the payoff patterns suggest the existence of different cognitive or other behavioral biases, depending upon the underlying asset.
Keywords: Structured Products, Behavioral Finance, Derivative Pricing
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