2020/05/10 by Jiexin Dai, Abootaleb Shirvani, Dai, Jiexin +3
Economics, Econometrics and Finance · #Capital Investment and Risk Analysis #Computational Finance (q-fin.CP) #FOS: Economics and business #Financial Markets and Investment Strategies #Pricing of Securities (q-fin.PR) #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.2005.05310
openalex publication_date 2020/05/10 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
When pricing options, there may be different views on the instantaneous mean return of the underlying price process. According to Black (1972), where there exist heterogeneous views on the instantaneous mean return, this will result in arbitrage opportunities. Behavioral finance proponents argue that such heterogenous views are likely to occur and this will not impact option pricing models proposed by rational dynamic asset pricing theory and will not give rise to volatility smiles. To rectify this, a leading advocate of behavioral finance has proposed a behavioral option pricing model. As there may be unexplored links between the behavioral and rational approaches to option pricing, in this paper we revisit Shefrin (2008) option pricing model as an example and suggest one approach to modify this behavioral finance option pricing formula to be consistent with rational dynamic asset pricing theory by introducing arbitrage transaction costs which offset the gains from arbitrage trades.