Psychological Barriers and Option Pricing

Journal of Futures Markets, Forthcoming

Posted: 23 Jul 2012 Last revised: 24 Oct 2013

See all articles by Bong-Gyu Jang

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH)

Changki Kim

Korea University Business School (KUBS)

Kyeong Tae Kim

POSTECH

Seungkyu Lee

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering

Dong-Hoon Shin

Korea University

Date Written: July 23, 2012

Abstract

Psychological barriers are prevalent among various asset classes, and it is important to consider their impact on the prices of derivative securities. This paper demonstrates the potential existence of such barriers on the S&P 500 Index and examines their impact on this index's rate of return and volatility. It focuses on deriving analytic European option prices under the assumption that the dynamics of stock prices follow a threshold model; this paper also evaluates this model's empirical performance relative to the Black-Scholes and constant elasticity of variance (CEV) models. The in-sample calibration result of the threshold model is found to be superior. Furthermore, it is found that the model provides an efficient hedging method in terms of dollar-value hedging errors.

Keywords: psychological barrier, option pricing, complete market, threshold model, regime switch, delta hedge

JEL Classification: C63, G13

Suggested Citation

Jang, Bong-Gyu and Kim, Changki and Kim, Kyeong Tae and Lee, Seungkyu and Shin, Dong-Hoon, Psychological Barriers and Option Pricing (July 23, 2012). Journal of Futures Markets, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2115355 or http://dx.doi.org/10.2139/ssrn.2115355

Bong-Gyu Jang (Contact Author)

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

Changki Kim

Korea University Business School (KUBS) ( email )

Anam-Dong, Seongbuk-Gu
Seoul 136-701, 136701
Korea
82.2.3290.2628 (Phone)

HOME PAGE: http://biz.korea.ac.kr/professor/changki-kim

Kyeong Tae Kim

POSTECH ( email )

Nam-gu, Hyoja-dong
Pohang, Kyung-Buk
Korea

Seungkyu Lee

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering ( email )

Dep. Industrial and Management Engineering POSTECH
San 31 Hyoja-dong Nam-gu
Pohang, Kyung-buk 790-783
Korea
82-(0)10-2790-4237 (Phone)

Dong-Hoon Shin

Korea University ( email )

1 Anam-dong 5 ka
Seoul, 136-701
Korea, Republic of (South Korea)

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