Growth Uncertainty, Rational Learning, and Option Prices
90 Pages Posted: 2 Oct 2020 Last revised: 2 Mar 2023
Date Written: October 24, 2022
Abstract
We examine the implications of introducing parameter uncertainty into endowment and production economies for index option premiums. We show that a production-based asset pricing model with rational belief updating better captures stylized facts than a consumption-based exchange framework, explaining the variance premium and option prices. The reason is that endogenous feedback from productivity news to consumption magnifies the effect of parameter learning on marginal utility, whereas exogenously determined cash flows dampen the possibility of endogenous response. The production model's ability to match empirical moments is robust to feeding actual productivity data and alternative priors.
Keywords: Priced parameter uncertainty, anticipated utility, Bayesian learning, variance premium, implied volatilities
JEL Classification: D83, E13, E32, G12
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