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

30 Pages Posted: 30 Mar 2011

See all articles by Alonso Pena

Alonso Pena

University of Cambridge; Fitch Group

Barbara Alemanni

SDA Bocconi

Giovanna Zanotti

University of Bergamo; SDA Bocconi

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Date Written: March 1, 2010


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 Model, S&P500 Index, Option Pricing

Suggested Citation

Pena, Alonso and Alemanni, Barbara and Zanotti, Giovanna, On the Role of Behavioral Finance in the Pricing of Financial Derivatives: The Case of the S&P 500 (March 1, 2010). CAREFIN Research Paper No. 03/2010. Available at SSRN: https://ssrn.com/abstract=1798607

Alonso Pena (Contact Author)

University of Cambridge ( email )

Trinity Ln
Cambridge, CB2 1TN
United Kingdom

Fitch Group ( email )

30 North Colonnade
Canary Wharf
London, E14 5GN
United Kingdom

Barbara Alemanni

SDA Bocconi ( email )

Via Bocconi 8
Milan, Milan 20136

Giovanna Zanotti

University of Bergamo ( email )

Via Salvecchio, 19
Bergamo, 24129

SDA Bocconi ( email )

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

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