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Cumulative Prospect Theory, Option Returns, and the Variance Premium.
- Source :
- Review of Financial Studies; Sep2019, Vol. 32 Issue 9, p3667-3723, 57p
- Publication Year :
- 2019
-
Abstract
- We develop a tractable equilibrium asset pricing model with cumulative prospect theory (CPT) preferences. Using GMM on a sample of U.S. equity index option returns, we show that by introducing a single common probability weighting parameter for both tails of the return distribution, the CPT model can simultaneously generate the otherwise puzzlingly low returns on both out-of-the-money put and out-of-the-money call options as well as the high observed variance premium. In a dynamic setting, probability weighting and time-varying equity return volatility combine to match the observed time-series pattern of the variance premium. Received May 30, 2017; editorial decision August 10, 2018 by Editor Andrew Karolyi. [ABSTRACT FROM AUTHOR]
Details
- Language :
- English
- ISSN :
- 08939454
- Volume :
- 32
- Issue :
- 9
- Database :
- Complementary Index
- Journal :
- Review of Financial Studies
- Publication Type :
- Academic Journal
- Accession number :
- 138205474
- Full Text :
- https://doi.org/10.1093/rfs/hhy127