Demand-Based Option Pricing

Posted: 28 Sep 2009

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: October 2009

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 proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of the unhedgeable parts of the two options. Empirically, we identify aggregate positions of dealers and end-users using a unique dataset, and show that demand-pressure effects make a contribution to well-known option-pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of index options, and cross-sectional tests show that demand impacts the expensiveness of single-stock options as well.

Suggested Citation

Gârleanu, Nicolae and Pedersen, Lasse Heje and Poteshman, Allen M., Demand-Based Option Pricing (October 2009). The Review of Financial Studies, Vol. 22, Issue 10, pp. 4259-4299, 2009, Available at SSRN: https://ssrn.com/abstract=1479109 or http://dx.doi.org/hhp005

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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