Option trading under uncertainty

52 Pages Posted: 18 Jan 2018 Last revised: 6 Aug 2020

See all articles by Paul Schneider

Paul Schneider

University of Lugano - Institute of Finance; Swiss Finance Institute

Date Written: March 5, 2019

Abstract

We investigate optimal trading strategies under uncertainty in a nonparametric no-arbitrage framework that is consistent with an arbitrary number of assets. We show that extreme aversion to uncertainty precludes trading, and that preference for uncertainty induces market participation.
In an empirical exercise using S&P 500 options, we find that magnitudes of optimal portfolio positions are small when uncertainty is high, whereas risk-based models usually predict the opposite. They also strongly co-move with trading volume. Differences in beliefs modelled through differences in agents' ambiguity priors lead to an equilibrium in which agents' ambiguity aversion is persistent over time.

Keywords: uncertainty, option trading, ambiguity

Suggested Citation

Schneider, Paul Georg, Option trading under uncertainty (March 5, 2019). Swiss Finance Institute Research Paper No. 18-02, Available at SSRN: https://ssrn.com/abstract=3103707 or http://dx.doi.org/10.2139/ssrn.3103707

Paul Georg Schneider (Contact Author)

University of Lugano - Institute of Finance ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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