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

See all articles by Jared DeLisle

Jared DeLisle

Utah State University

Dean Diavatopoulos

Seattle University

Andy Fodor

Ohio University

Kevin Krieger

University of West Florida

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

DeLisle, Jared and Diavatopoulos, Dean and Fodor, Andy and Krieger, Kevin, Anchoring and Probability Weighting in Option Prices (July 15, 2016). Journal of Futures Markets 37(6), 614-638.. Available at SSRN: https://ssrn.com/abstract=2561887 or http://dx.doi.org/10.2139/ssrn.2561887

Jared DeLisle

Utah State University ( email )

Logan, UT 84322
United States
435-797-0885 (Phone)

Dean Diavatopoulos

Seattle University ( email )

901 12th Avenue
Seattle, WA 98122
United States

Andy Fodor (Contact Author)

Ohio University ( email )

514 Copeland Hall
Athens, OH 45701
United States
740.593.0259 (Phone)

Kevin Krieger

University of West Florida ( email )

11000 University Parkway
Pensacola, FL 32514-5750
United States

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