Siddiqi, Hammad (2009): Coarse Thinking and Pricing a Financial Option.

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Abstract
Mullainathan et al [Quarterly Journal of Economics, May 2008] present a formalization of the concept of coarse thinking in the context of a model of persuasion. The essential idea behind coarse thinking is that people put situations into categories and the values assigned to attributes in a given situation are affected by the values of corresponding attributes in other cocategorized situations. We derive a new option pricing formula based on the assumption that the market consists of coarse thinkers as well as rational investors. The new formula, called the behavioral BlackScholes formula is a generalization of the BlackScholes formula. The new formula provides an explanation for the implied volatility skew puzzle in index options. In contrast with the BlackScholes model, the implied volatility backedout from the behavioral BlackScholes formula is a constant. This finding suggests that the volatility skew (smile) may be a reflection of coarse thinking. That is, the skew is seen if rational investors are assumed to exist when actual investors are heterogeneous; coarse thinkers and rational investors.
Item Type:  MPRA Paper 

Original Title:  Coarse Thinking and Pricing a Financial Option 
Language:  English 
Keywords:  Coarse Thinking, Financial Options, Rational Pricing. Implied Volatility, Implied Volatility Skew, Implied Volatility Smile, BlackScholes Model 
Subjects:  G  Financial Economics > G1  General Financial Markets > G12  Asset Pricing; Trading volume; Bond Interest Rates D  Microeconomics > D0  General > D00  General 
Item ID:  21749 
Depositing User:  Hammad Siddiqi 
Date Deposited:  31. Mar 2010 06:01 
Last Modified:  20. Feb 2013 03:54 
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URI:  http://mpra.ub.unimuenchen.de/id/eprint/21749 