Abstract
An economy with agents having constant yet heterogeneous degrees of relative risk aversion prices assets as though there were a single decreasing relative risk aversion "pricing representative" agent. The pricing kernel has fat tails, and option prices do not conform to the Black-Scholes formula. Implied volatility exhibits a "smile." Heterogeneity as 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 money put options have relatively high risk aversion (or relatively high subjective probability assessments of low market outcomes). The essence of this explanation is investor heterogeneity.
Original language | English |
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Pages (from-to) | 7-27 |
Number of pages | 21 |
Journal | Review of Derivatives Research |
Volume | 4 |
Issue number | 1 |
DOIs | |
State | Published - 2000 |