Why are Put Options So Expensive?

Abstract:     
This paper studies the "overpriced puts puzzle" - the finding that historical prices of the S&P 500 put options have been too high and incompatible with the canonical asset-pricing models, such as CAPM and Rubinstein (1976) model. Simple trading strategies that involve selling at-the-money and out-of-the-money puts would have earned extraordinary profits. To investigate whether put returns could be rationalized by another, possibly nonstandard equilibrium model, we implement a new methodology. The methodology is "model-free" in the sense that it requires no parametric assumptions on investors' preferences. Furthermore, the methodology can be applied even when the sample is affected by certain selection biases (such as the Peso problem) and when investors' beliefs are incorrect.

We find that no model within a fairly broad class of models can possibly explain the put anomaly.

Keywords: Market Market Efficiency Hypothesis, Rational Learning, Option Valuation, Risk-Neutral Density, Peso Problem

JEL Classifications: G12, G13, G14

Working Paper Series