Model Uncertainty and Option Markets with Heterogeneous Beliefs

Buraschi, Andrea; Jiltsov, Alexei

doi:10.1111/j.1540-6261.2006.01006.x

Cited by 318 publications

(175 citation statements)

References 86 publications

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“…Similar proxies based on the options literature are used in previous studies (e.g., De Bondt (1993), Shefrin (1999), Bollen and Whaley (2004), and Buraschi and Jiltsov (2006)). The literature suggests that the SPX put volatility smirk is an effective proxy for heterogeneous beliefs between investors.…”

Section: B Implied Volatility Differential (Ivd)mentioning

confidence: 99%

Stock Market Mispricing: Money Illusion or Resale Option?

Chen¹,

Lung²,

Wang³

2009

J. Financ. Quant. Anal.

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We examine two hypotheses to explain stock mispricing: (a) the money illusion hypothesis (Modigliani and Cohn (1979)) and (b) the resale option hypothesis (Scheinkman and Xiong (2003)). We find that the money illusion hypothesis may explain the level, but not the volatility of mispricing in the US market. By contrast, the stock resale option hypothesis, which stems from heterogeneous beliefs about future dividend growth rates and short-sales constraints, can explain both the level and the volatility of mispricing. The evidence suggests that while the two hypotheses complement each other in explaining the level of mispricing, the resale option hypothesis provides a more coherent explanation for asset price bubbles, in which extraordinarily high price levels are often accompanied by excessive volatility and frenzied trading.JEL classification: E31, E44, G12, G14

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Section: B Implied Volatility Differential (Ivd)mentioning

confidence: 99%

Stock Market Mispricing: Money Illusion or Resale Option?

Chen¹,

Lung²,

Wang³

2009

J. Financ. Quant. Anal.

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“…His model captures the contractions associated with the Great Depression and the two World Wars, but it does not match the evidence around the 1987 crash, when the output level remained smooth. and/or fundamentals; see, e.g., Bansal, Gallant, and Tauchen (2007), Bondarenko (2003), Brown and Jackwerth (2004), Buraschi and Jiltsov (2006), Chabi-Yo, Garcia, and Renault (2008), David and Veronesi (2002), and Garcia, Luger, and Renault (2001. These papers do not study the determinants of stock market crashes, the permanent shift in the implied volatility smirk that followed the 1987 events, and the difference between implied volatility functions for individual and index stock options.…”

Section: Introductionmentioning

confidence: 99%

Explaining Asset Pricing Puzzles Associated with the 1987 Market Crash

2010

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractThe 1987 market crash was associated with a dramatic and permanent steepening of the implied volatility curve for equity index options, despite minimal changes in aggregate consumption. We explain these events within a general equilibrium framework in which expected endowment growth and economic uncertainty are subject to rare jumps. The arrival of a jump triggers the updating of agents' beliefs about the likelihood of future jumps, which produces a market crash and a permanent shift in option prices. Consumption and dividends remain smooth, and the model is consistent with salient features of individual stock options, equity returns, and interest rates.

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“…The chapter by Barone-Adesi et al (2011) in this handbook introduces a technique based on the state price density measured from stock and option data to measure fluctuations of market sentiment. In other related work, Buraschi and Jiltsov (2006) and Beber, Buraschi, and Breedon (2010) provided empirical evidence that the volatility smile of S&P500 index options and currency options is positively correlated with measures of belief dispersion.…”

Section: Endogenous Risk and Time-varying Risk Premiummentioning

confidence: 99%

Bubbles, Crises, and Heterogeneous Beliefs

Xiong

2013

Handbook on Systemic Risk

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This paper reviews the quickly growing literature that builds on heterogeneous beliefs, a widely observed attribute of individuals, to explain bubbles, crises, and endogenous risk in financial markets.Wei Xiong Princeton University Department of Economics Bendheim Center for Finance Princeton, NJ 08450 and NBER wxiong@princeton.edu 1The history of financial markets has been dotted with episodes of bubbles, during which market values of assets vastly exceeded reasonable assessments of their fundamental value. Asset price bubbles can lead to severe economic consequences ranging from wasteful over-investment and frenzied trading during booms to devastating financial crises and depressed real economies during busts. Economists have emphasized many aspects of bubbles and crises. Minsky (1974) advocated the view that excessive expansion of bank credit due to optimism can fuel a speculative euphoria and slowly lead the economy to a crisis. Kindleberger (1978) stressed that irrationally optimistic expectations frequently emerge among investors in the late stages of major economic booms and lead firm managers to over-invest, over-promise, and over-leverage, which sow the seeds for an eventual collapse after they fail to deliver on their promises.Shiller (2000) highlighted a host of psychological biases people use in forming a feedback mechanism, through which initial price increases caused by certain initial precipitating factors such as new technology innovations feed back into even higher asset prices through increased investor confidence and expectations. Allen and Gale (2007) focused on agency problems of professional managers who actively seek unwarranted risk, which leads to bubbles and crises.This chapter reviews a quickly growing body of work that was started by Harrison and Kreps (1978) that studies bubbles and crises based on heterogeneous beliefs, a widely observed attribute of individuals.In a market in which agents disagree about an asset's fundamental and short sales are constrained, an asset owner is willing to pay a price higher than his own expectation of the asset's fundamental because he expects to resell the asset to a future optimist at an even higher price. Such speculative behavior leads to a bubble component in asset prices. This approach does not require a substantial amount of aggregate belief distortions to generate a significant price bubble. Instead, the bubble component builds on the fluctuations of investors' heterogeneous beliefs. Even when investors' aggregate beliefs are unbiased, intensive fluctuations of their heterogeneous beliefs can lead to a significant price bubble through frenzied trading (e.g., Scheinkman and Xiong (2003)). This approach is flexible enough to incorporate several important aspects of bubbles and crises, such as over-investment (e.g., Bolton, ) and crashes (e.g., Abreu and Brunnermeier (2003) and Hong and Stein (2003)). Heterogeneous beliefs can also lead to credit cycles (e.g., Geanakoplos (2010)). The speculation induced by heterogeneous beliefs also lea...

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Model Uncertainty and Option Markets with Heterogeneous Beliefs

Cited by 318 publications

References 86 publications

Stock Market Mispricing: Money Illusion or Resale Option?

Stock Market Mispricing: Money Illusion or Resale Option?

Explaining Asset Pricing Puzzles Associated with the 1987 Market Crash

Bubbles, Crises, and Heterogeneous Beliefs

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