A Portfolio Perspective on Option Pricing Anomalies

52 Pages Posted: 23 Jul 2003

See all articles by Joost Driessen

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management; Tilburg University - Center for Economic Research (CentER)

Pascal J. Maenhout

INSEAD - Finance

Date Written: October 2004

Abstract

We empirically study the economic benefits of giving investors access to index options in the context of the standard asset allocation problem. We analyze both expected-utility and non-expected-utility investors in order to understand who optimally buys and sells in option markets. We solve the portfolio problem with a flexible empirical methodology that does not rely on specific assumptions about the process of the underlying equity index. Using data on S&P 500 index options (1987-2001) we consider returns on OTM put options and ATM straddles. CRRA investors find it always optimal to short put options and straddles, regardless of their risk aversion. The option positions are economically and statistically significant and robust to corrections for transaction costs, margin requirements, and Peso problems. Surprisingly, loss-averse and disappointment-averse investors also optimally hold short positions in puts and straddles. Because derivatives are in zero net supply, this suggests that generating empirically relevant option prices in an equilibrium model is a challenging task, even with investor heterogeneity and even with commonly-studied behavioral preferences. Only when loss aversion is combined with highly distorted probability assessments, can we obtain positive portfolio weights for puts and straddles.

Suggested Citation

Driessen, Joost and Maenhout, Pascal J., A Portfolio Perspective on Option Pricing Anomalies (October 2004). Available at SSRN: https://ssrn.com/abstract=424384 or http://dx.doi.org/10.2139/ssrn.424384

Joost Driessen (Contact Author)

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Pascal J. Maenhout

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France

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