Prices of State-Contingent Claims Implicit in Option Prices

32 Pages Posted: 12 Aug 2015

See all articles by Douglas T. Breeden

Douglas T. Breeden

Duke University Fuqua School of Business

Robert H. Litzenberger

University of Pennsylvania - Finance Department

Date Written: August 11, 2015

Abstract

This paper implements the time-state preference model in a multi-period economy, deriving the prices of primitive securities from the prices of call options on aggregate consumption. These prices permit an equilibrium valuation of assets with uncertain payoffs at many future dates. Furthermore, for any given portfolio, the price of a $1.00 claim received at a future date, if the portfolio's value is between two given levels at that time, is derived explicitly from a second partial derivative of its call-option pricing function. An intertemporal capital asset pricing model is derived for payoffs that are jointly lognormally distributed with aggregate consumption. It is shown that using the Black-Scholes equation for options on aggregate consumption implies that individuals' preferences aggregate to isoelastic utility.

Suggested Citation

Breeden, Douglas T. and Litzenberger, Robert H., Prices of State-Contingent Claims Implicit in Option Prices (August 11, 2015). Journal of Business, Vol. 51, No. 4, 1978, Available at SSRN: https://ssrn.com/abstract=2642349

Douglas T. Breeden (Contact Author)

Duke University Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
9196602892 (Phone)

Robert H. Litzenberger

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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