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Anchoring Heuristic in Option Pricing

Siddiqi, Hammad (2015): Anchoring Heuristic in Option Pricing.

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An anchoring adjusted option pricing model is put forward in which the risk of the underlying stock is used as a starting point that gets adjusted upwards to estimate call option risk. Anchoring bias implies that such adjustments are insufficient. Black-Scholes formula is a special case with no anchoring bias. The new model provides a unified explanation for a number of option pricing puzzles including the implied volatility skew, superior historical performance of covered call writing, and worse-than-expected performance of zero beta straddles. The model is also consistent with recent empirical findings regarding leverage adjusted option returns. Anchoring adjusted jump diffusion and stochastic volatility models are also put forward.

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