Options Markets, Self-Fulfilling Prophecies, and Implied Volatilities

Posted: 10 Sep 1999

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Joseph Cherian

Asia School of Business; Johnson Graduate School of Management

Date Written: October 1994

Abstract

The Black-Scholes formula is the "industry standard" for pricing options on a variety of instruments. This paper shows that even when markets are incomplete, the Black- Scholes option pricing formula can arise in an equilibrium merely from self-fulfilling beliefs that it is the correct pricing formula. In such an equilibrium, the presence of traders speculating on the stock's underlying price movements can cause implied volatilities to deviate from future volatilities. This result provides a possible explanation for the recent empirical evidence supporting an "overreactions" effect in implied volatilities.

JEL Classification: G13, G14

Suggested Citation

Jarrow, Robert A. and Cherian, Joseph, Options Markets, Self-Fulfilling Prophecies, and Implied Volatilities (October 1994). Available at SSRN: https://ssrn.com/abstract=5703

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Joseph Cherian (Contact Author)

Asia School of Business ( email )

11 Jalan Dato Onn
Kuala Lumpur, 50480
Malaysia
+6 03 2023 3244 (Phone)

HOME PAGE: http://www.josephcherian.me/

Johnson Graduate School of Management ( email )

11 E. Loop Rd. 3rd Floor
Tata Innovation Center, Cornell Tech Campus
New York, NY 10044
United States

HOME PAGE: http://www.josephcherian.me/

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
1,366
PlumX Metrics