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Review of Finance Advance Access published online on August 27, 2007
Review of Finance, doi:10.1093/rof/rfm024
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Copyright © The Author 2007. Published by Oxford University Press on behalf of the European Finance Association.

An Empirical Portfolio Perspective on Option Pricing Anomalies*

Joost Driessen1 and Pascal Maenhout2

1 University of Amsterdam
2 INSEAD

We empirically study the economic benefits of giving investors access to index options in the standard portfolio problem, analyzing both expected-utility and nonexpected-utility investors in order to understand who optimally buys and sells options. Using data on S&P 500 index options, CRRA investors find it always optimal to short out-of-the-money puts and at-the-money straddles. The option positions are economically and statistically significant and robust to corrections for transaction costs, margin requirements, and Peso problems. Loss-averse and disappointment-averse investors also optimally hold short option positions. Only with highly distorted probability assessments can we obtain positive portfolio weights for puts (cumulative prospect theory and anticipated utility) and straddles (anticipated utility).

JEL Classification: G11, G12

* We are very grateful for the detailed comments and suggestions of two anonymous referees. We would like to thank Nick Barberis, Michael Brennan, Enrico Diecidue, Bernard Dumas, Robert Engle, Stephen Figlewski, Francisco Gomes, Kris Jacobs, Owen Lamont and seminar participants at Yale, the London School of Economics, the University of Amsterdam, City University Business School London, Stockholm School of Economics and the 2003 EFA, 2004 AFA and 2004 Inquire Europe meetings for helpful comments and suggestions. We gratefully acknowledge the financial support of Inquire Europe.


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