Demand-Based Option Pricing

Abstract

, and the 2005 WFA Meetings. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

Liquidity effect in OTC options markets: Premium or discount?

“…9 All these factors result in an increase in the slope of the option supply curve when there is less liquidity, consistent with Cetin, Jarrow, Protter, and Warachka (2006). The impact of a steeper supply curve on option prices and bid-ask spreads can be understood within the theoretical model of Garleanu, Pedersen, and Poteshman (2009). Given the inventory of the dealer, a steeper supply curve would result in wider bid-ask spreads, since the difference in prices for a unit (footnote continued) relationship with price.…”

“…In addition, option dealers face model misspecification and biased parameter estimation risk (Figlewski, 1989). These factors result in some part of the risk in options becoming unhedgeable, leading to an upward sloping supply curve (Bollen and Whaley, 2004;Jarrow and Protter, 2007;and Garleanu, Pedersen, and Poteshman, 2009). In addition, since dealers in this market are net short, they may hit their capital constraints more often if they have to sell more options to make a market (Brunnermeier and Pedersen, 2009).…”

Pricing in an equilibrium based model for a large investor

“…Remark 1 Theorem 1 was formulated in [10] (Theorem 1) in a different form and without a formal proof. For the sake of mathematical completeness we provide a proof here.…”

“…Liquidity is a complex concept standing for the ease of trading of a security. (Il)liquidity can have different sources, such as inventory risk-Stoll [15], transaction costs-Cvitanić and Karatzas [4], uncertain holding horizons-Huang [13], asymmetry of information-Gârleanu and Pedersen [9], demand pressure-Gârleanu et al [10], search friction-Duffie et al [6], stochastic supply curve-Çetin et al [3] and demand for immediacy-Grossman and Miller [12], among many others (see Amihud et al [1] for a thorough literature overview).…”

The cross-section of average delta-hedge option returns under stochastic volatility

“…The large negative option premium has led to the surge of empirical and analytical studies which also attempt to find the sources of this premium. See Benzoni et al (2005), Bondarenko (2003), Branger and Schlag (2008), Broadie et al (2009), Cao and Huag (2008), Constantinides et al (2009), Garleanu et al (2009), Low and Zhang (2005), Santa-Clara and Saretto (2009), and Wu (2007), among others. 3 For instance, Driessen et al (2009) relate the option risk-premium to correlation risk.…”