Essays on Pricing Equity and Commodity Derivatives PDF Download

Author: Sang Baum Kang
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Languages : en
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Book Description
"This thesis consists of two essays on the pricing of equity and commodity derivatives. In the first essay, we investigate overpricing of call options. A recent empirical study by Constantinides, Czerwonko, Jackwerth and Perrakis (2011) documents that S&P 500 Index call options are frequently overpriced in the sense that any rational agent can improve her expected utility by writing these calls. Little work has addressed why such apparent mispricing is so common. We show that such overpricing of call options is consistent with equilibrium in an economy where investors have portfolio constraints and heterogeneity in beliefs on both expected return and volatility. Within our model, call options are overpriced when belief dispersion is large and the capacity of liquidity providers is small. Empirically, we propose a model-free methodology to investigate the determinants of option overpricing and verify my explanation. The findings are robust to various implementations of the empirical study.In the second essay, we study the variance risk premia calculated from the crude oil futures and options market in a model-free way. First, we establish that the variance risk premia are negative for various maturities, a finding that reflects the compensation for crude oil option writers. While the existing literature focuses on one month maturity, we analyze maturities beyond one month because commodity hedging demands for futures and options often have longer horizons. Furthermore, for the first time in the literature, we document that the variance risk premia predict the commodity futures returns after several information variables, such as storage level and hedging pressure, are controlled for. The finding is robust across various implementations of predictive regressions and out-of-sample tests. Finally, we develop a stylized economic model to show that the hedge demand for both futures and options may explain such predictability." --