We propose implied spreads (IS) and normalized implied spreads (NIS) as simple measures to characterize option prices. IS is the credit spread of an option's implied bond, the portfolio long a risk-free bond and short a put option. NIS normalizes IS by the risk-neutral default probability and...

This paper develops a dynamic programming model of the optimal refunding strategy and the corresponding value of a callable bond. The model differs from previous work on this subject primarily in that it explicitly admits the possibility of differences between the issuer's expectations of future...

Widespread violations of stochastic dominance by one-month S&P 500 index call options over 1986-2006 imply that a trader can improve expected utility by engaging in a zero-net-cost trade net of transaction costs and bid-ask spread. Although pre-crash option prices conform to the...

We model the demand-pressure effect on prices when options cannot be perfectly hedged. 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...

The optimal portfolio of a utility-maximizing investor trading in the S&P 500 index and cash, subject to proportional transaction costs, becomes stochastically dominated when overlaid with a zero-net-cost portfolio of S&P 500 options bought at their ask and written at their bid price in most...

We document that the implied volatility skew of S&P 500 index puts is non-decreasing in the disaster index and risk-neutral variance, contrary to the implications of a broad class of no-arbitrage models. The key to the puzzle lies in recognizing that, as the disaster risk increases, customers...

Investors in option markets price in a substantial collective government bailout guarantee in the financial sector, which puts a floor on the equity value of the financial sector as a whole, but not on the value of the individual firms. The guarantee makes put options on the financial sector...

The historical returns on equity index options are well known to be strikingly negative. That is typically explained either by investors having convex marginal utility over stock returns (e.g. crash/variance aversion) or by intermediaries demanding a premium for hedging risk. This paper examines...

We develop a new parametric estimation procedure for option panels observed with error which relies on asymptotic approximations assuming an ever increasing set of observed option prices in the moneyness- maturity (cross-sectional) dimension, but with a fixed time span. We develop consistent...

By applying stochastic dominance arguments, upper bounds on the reservation write price of European calls and puts and lower bounds on the reservation purchase price of these derivatives are derived in the presence of proportional transaction costs incurred in trading the underlying security....