Option Valuation in the Presence of Market Sentiment: Application to Listed Companies in the CAC40 Index

Asset pricing theory based on rationality was widely criticized in literature. Indeed, the non-inclusion of investor behavior and assuming market efficiency led to the weaknesses of option valuation through the traditional Black and Scholes model (1973). In this paper we examine the effect of the inclusion of investor behavior in the option pricing model. We test whether the Black and Scholes model in presence of sentiment behavior can lead to an improvement of the calculation of call price. Using daily data of 30 listed companies of France in the CAC40 index for the period June 18, 2009 to May 09, 2018, results showed that the introduction of sentiment effect in the Black and Scholes model provides better estimates of the call price than that obtained by the standard Black-Scholes model. In fact, we obtain an average gain of about 44% in terms of relative change in mean square error between both methods.

COVID-19, Stock Market, Exchange Rate, Oil Prices, Unemployment, Inflation, Geopolitical Risk Nexus, the Case of the BRICS Nations

This chapter attempts to study the impact of the COVID-19 pandemic on the stock markets of the BRICS nations. Such an exercise will have an important bearing on portfolio allocation in the context of the BRICS. The major contribution of the chapter in the extant literature is to examine based on the multifactor model of the capital asset pricing theory, how uncertainty owing to the pandemic interplay with the geopolitical index to impact the stock market of the BRICS. Further, the major macroeconomic factors are used as control variables. The daily observations were used from 31 December 2019 to 30 December 2020. The results based on the quantile regression model demonstrate the asymmetric response of the stock market to the pandemic. The policy implication that follows from this study is the need for strategic intervention of the central bank to ease the liquidity challenges in the crisis period.

Solving the Muni Puzzle: Who Benefits from Tax Exemption of Government Debt?

I provide a new approach to measuring interest savings associated with issuing tax-exempt municipal bonds (munis) and present empirical evidence offering a solution to the long-standing “muni puzzle.” I show that the tax policy is effective and consistent with theory once I account for idiosyncratic issuer risk and investor preferences. I match tax-exempt munis to near-identical taxable munis issued by the same government at the same time with the same security characteristics to identify the slope of and the trend in implied marginal tax rates. Results of the random coefficients model, which mitigates issuer- and issuance-level unobserved effects, predict the slope of the marginal tax rate to be consistent with asset pricing theory and the tax profile of the typical muni investor. Findings also imply cyclicality over time and heterogeneity in implied marginal tax rates across issuers due to variations in idiosyncratic risk.

OPTION PRICING IN MARKETS WITH INFORMED TRADERS

The objective of this paper is to introduce the theory of option pricing for markets with informed traders within the framework of dynamic asset pricing theory. We introduce new models for option pricing for informed traders in complete markets, where we consider traders with information on the stock price direction and stock return mean. The Black–Scholes–Merton option pricing theory is extended for markets with informed traders, where price processes are following continuous-diffusions. By doing so, the discontinuity puzzle in option pricing is resolved. Using market option data, we estimate the implied surface of the probability for a stock upturn, the implied mean stock return surface, and implied trader information intensity surface.

Investor and market overreaction: a retrospective

PurposeAre the capital markets of leading industrialized nations rational and efficient? This powerful hypothesis was badly dented by the work of De Bondt and Thaler (1985) on stock market overreaction and by subsequent research on momentum and reversals in prices and earnings.Design/methodology/approachHuman psychology, at times predictably irrational, drives the markets. This paper investigates this issue.FindingsThe author reviews the origins of the idea of overreaction, how behavioral insights modify standard asset pricing theory and how they contribute to our understanding of the world of finance.Originality/valueThe paper reveals the origins of the idea of overreaction, how behavioral insights modify standard asset pricing theory and how they contribute to our understanding of the world of finance.

Insurance Cycles, Spanning and Regulation

This paper offers a novel explanation of the financial underwriting cycle in the property-liability insurance industry. By doing so it resolves that significant anomaly in asset pricing theory posed by cycles in the efficient pricing of insurance coverage. In contrast to the reliance on a variety of institutional or capital market failures underlying all previous explanations of this cycle, we directly augment the complete-markets environment of traditional asset-pricing models through the presence of a single source of risk that cannot be fully hedged through existing financial markets. We realistically interpret this source of risk as unforecastable noise in the implementation of insurance regulations. Cycles in the value of underwriting insurance coverage can arise in this simple variant of a standard complete-markets pricing model owing to the effect of such regulatory risk. We offer a sufficient condition for a stable cycle to endogenously exist in market equilibrium and illustrate this condition in the context of a representative insurance firm and a regulator pursuing a countercyclical policy with noisy implementation. Interestingly, while insurance pricing is efficient in the absence of the regulator, cyclic pricing and underwriting profitability can be induced by a countercyclical regulator policy designed to stabilize the very cycle it creates.