Dynamic Equilibrium with Overpriced Put Options
26 Pages Posted: 4 Apr 2006
Date Written: November 2004
It is a well-known anomaly that prices of put options are too high when options are out-of-the-money. This paper presents a simple general equilibrium model of the market where European put options become substantially overpriced when they are out-of-the-money. Overpricing is due to the presence of short-sale constraints on trading stocks and derivatives, as well as the heterogeneity between investors. We confirm the predicting power of the model by comparing its implications with existing empirical results.
Keywords: Derivatives, equilibrium, arbitrage
JEL Classification: D52, G12, G13
Suggested Citation: Suggested Citation