Abstract
An economy with agents having constant yetheterogeneous degrees of relative risk aversion prices assetsas though there were a single decreasing relative risk aversion“pricing representative” agent. The pricing kernel has fattails, and option prices do not conform to the Black-Scholesformula. Implied volatility exhibits a “smile.” Heterogeneityas the source of non-stationary pricing fits Rubenstein's (1994)interpretation of the “over-pricing” as an indication of “crash-o-phobia”.Rubinstein's term suggests that those who hold out-of-the moneyput options have relatively high risk aversion (or relativelyhigh subjective probability assessments of low market outcomes).The essence of this explanation is investor heterogeneity.
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Benninga, S., Mayshar, J. Heterogeneity and Option Pricing. Review of Derivatives Research 4, 7–27 (2000). https://doi.org/10.1023/A:1009639211414
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DOI: https://doi.org/10.1023/A:1009639211414