Demand-Based Option Pricing

48 Pages Posted: 5 Nov 2008

See all articles by Nicolae Gârleanu

Nicolae Gârleanu

affiliation not provided to SSRN

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: January 2006

Abstract

We model demand-pressure effects on option prices. The model shows that demand pressure in one option contract increases its price by an amount pro- portional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount propor- tional to the covariance of their unhedgeable parts. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects contribute to well-known option-pricing puzzles. In- deed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of both index options and single-stock options

Suggested Citation

Gârleanu, Nicolae and Pedersen, Lasse Heje and Poteshman, Allen M., Demand-Based Option Pricing (January 2006). NYU Working Paper No. S-DRP-06-01, Available at SSRN: https://ssrn.com/abstract=1295842

Nicolae Gârleanu (Contact Author)

affiliation not provided to SSRN

No Address Available

Lasse Heje Pedersen

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance ( email )

340 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-265-0565 (Phone)
217-244-3102 (Fax)

HOME PAGE: http://www.business.uiuc.edu/poteshma

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