Growth Uncertainty, Rational Learning, and Option Prices

90 Pages Posted: 2 Oct 2020 Last revised: 2 Mar 2023

See all articles by Mykola Babiak

Mykola Babiak

Lancaster University Management School

Roman Kozhan

University of Warwick - Warwick Business School

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

Suggested Citation

Babiak, Mykola and Kozhan, Roman, Growth Uncertainty, Rational Learning, and Option Prices (October 24, 2022). Available at SSRN: https://ssrn.com/abstract=3675548 or http://dx.doi.org/10.2139/ssrn.3675548

Mykola Babiak (Contact Author)

Lancaster University Management School ( email )

Bailrigg
Lancaster, LA1 4YX
United Kingdom

HOME PAGE: http://https://sites.google.com/site/mykolababiak/home

Roman Kozhan

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

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