Psychology, Stock/FX Trading, and Option Prices

Journal of Behavioral Finance, Forthcoming

36 Pages Posted: 27 Jan 2012 Last revised: 21 Apr 2014

See all articles by Alan Beilis

Alan Beilis

affiliation not provided to SSRN

Jan Dash

Bloomberg LP

Jacqueline Volkman Wise

Temple University - Risk Management & Insurance & Actuarial Science

Date Written: January 25, 2012

Abstract

The financial crisis of 2008 had many putative causes. Psychology was an important driver for human decisions underlying these causes. However, quantitative financial models have no “knobs” to dial psychology parameters, and so arguably cannot possibly cope with financial crises. We have no illusions of the difficulty of including psychology in financial modeling. Here we take a first step by considering how a particular aspect of psychology can influence an underlying security and subsequent option prices, in a quantitative model. The underlying security can be a stock or an FX rate. There are three steps. First we investigate how psychological regret and fear impact trading selling behavior. Second we use results from the first step to link this changed trading behavior with induced changes in underlying security prices. Third, we consider changes in option prices due to these induced underlying security price changes. The results can be expressed either as a modified effective dividend for stock options, a modified effective interest rate for FX options, or an unusual change in implied volatility. Options analysis for some USDCAD FX European options with implied parameters indicates this approach has some empirical relevance.

The contribution of this paper is thus threefold: 1. The paper breaks ground by emphasizing the desirability of incorporating interdisciplinary explicit interaction between behavioral finance and securities modeling, 2. The paper provides a definite model with a quantitative mechanism of how a particular psychological behavior can influence the prices of some securities, and 3. The paper shows that this model can facilitate the description of some illustrative option data.

Keywords: Regret, Fear, Selling, Trading, Options

JEL Classification: D81, G02, G12, G13

Suggested Citation

Beilis, Alan and Dash, Jan and Volkman Wise, Jacqueline, Psychology, Stock/FX Trading, and Option Prices (January 25, 2012). Journal of Behavioral Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1992016 or http://dx.doi.org/10.2139/ssrn.1992016

Alan Beilis

affiliation not provided to SSRN ( email )

Jan Dash

Bloomberg LP ( email )

731 Lexington Ave
New York, NY 10022
United States

Jacqueline Volkman Wise (Contact Author)

Temple University - Risk Management & Insurance & Actuarial Science ( email )

Fox School of Business and Management
1301 Cecil B. Moore Ave.
Philadelphia, PA 19122
United States

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