Download this Paper Open PDF in Browser

On the Role of Behavioral Finance in the Pricing of Financial Derivatives: The Case of the S&P 500

29 Pages Posted: 26 Aug 2010  

Giovanna Zanotti

University of Bergamo; SDA Bocconi

Alonso Pena

SDA Bocconi

Barbara Alemanni

SDA Bocconi

Multiple version iconThere are 2 versions of this paper

Date Written: August 25, 2010

Abstract

The object of this study was to investigate some implications of the tenets of behavioral finance on the pricing of financial derivatives. In particular, based on the work by Wolff et al (2009) we have investigated how prospect theory (Kahneman and Tversky, 1979) can be intregrated into the Black and Scholes (1973) option pricing framework. We have then used the resulting “behavioral version” of the Black-Scholes equation to price market quoted options. As an empirical test we have calibrated three-month market-quoted call options on the Standard & Poor’s 500 index (SPX) at the Chicago Board of Options Exchange (CBOE) during the period January to December 2007. As a comparison, we have also calibrated the Heston (1993) stochastic volatility option pricing model to the same contracts. Our results show that during the period of study the market option prices are captured better by the behavioral version of the Black-Scholes equation than by the Heston stochastic volatility model. Further work is required to investigate if this is the case for other option types and under different market conditions.

Keywords: Black-Scholes Equation, Prospect Theory, Heston Stochastic Volatility

JEL Classification: G12, G19

Suggested Citation

Zanotti, Giovanna and Pena, Alonso and Alemanni, Barbara, On the Role of Behavioral Finance in the Pricing of Financial Derivatives: The Case of the S&P 500 (August 25, 2010). Available at SSRN: https://ssrn.com/abstract=1664996 or http://dx.doi.org/10.2139/ssrn.1664996

Giovanna Zanotti (Contact Author)

University of Bergamo ( email )

Via Salvecchio, 19
Bergamo, 24129
Italy

SDA Bocconi ( email )

via Bocconi 8
Milano, MI 20135
Italy
+390258366101 (Phone)

Alonso Pena

SDA Bocconi ( email )

Via Bocconi 8
Milan, Milan 20136
Italy

Barbara Alemanni

SDA Bocconi ( email )

Via Bocconi 8
Milan, Milan 20136
Italy

Paper statistics

Downloads
486
Rank
23,639
Abstract Views
2,412