Zur Shapira

Kent Miller
Purdue University

This study applies behavioral decision theory to option pricing. The theoretical discussion offers hypotheses about buyers’ and sellers’ subjective valuations of call and put options. We used a questionnaire to collect option pricing data to test these hypotheses. The evidence indicates: (1) buyers and sellers price options below their expected values; (2) buyers’ prices are consistently below sellers’ prices; (3) irrelevant outcomes decrease option values; (4) discount rates vary with the option time horizon; and (5) changes in option values do not fully reflect increases in exercise prices. The findings point out the usefulness of behavioral decision theory for understanding managers’ real option decisions. They also reveal the cognitive bases for incomplete real option markets.