Anchoring and Probability Weighting in Option Prices
Journal of Futures Markets 37(6), 614-638.
36 Pages Posted: 9 Feb 2015 Last revised: 16 Jul 2017
Date Written: July 15, 2016
Abstract
Behavioral theories contend that the human decision-making process tends to both incorporate anchor points and improperly weight low probability events. In this study, we find evidence that equity option market investors anchor to prices and incorporate a probability weighting function similar to that proposed by cumulative prospect theory. The biases result in inefficient prices for put options when firms have relatively high or relatively low implied volatilities. This has implications for the cost of hedging long portfolios and long individual equity positions.
Keywords: Prospect theory, Mental accounting, Option prices
JEL Classification: G1, G13
Suggested Citation: Suggested Citation