Anchoring and Adjustment Heuristic in Option Pricing

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

Abstract

Based on experimental and anecdotal evidence, an anchoring-adjusted option pricing model is developed in which the volatility of the underlying stock return is used as a starting point that gets adjusted upwards to form expectations about call option volatility. I show that the anchoring price lies within the bounds implied by risk-averse expected utility maximization when there are proportional transaction costs. The anchoring model provides a unified explanation for key option pricing puzzles. Two predictions of the anchoring model are empirically tested and found to be strongly supported with nearly 26 years of options data.

• Item Type: MPRA Paper
• Language: English
• Keywords: Anchoring, Implied Volatility Skew, Covered Call Writing, Zero-Beta Straddle, Leverage Adjusted Option Returns
• Subjects: G - Financial Economics > G0 - General > G02 - Behavioral Finance: Underlying Principles; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing

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