Huang, J (2002) Impact on option prices of divergent consumer confidence. Working Paper. The Department of Accounting and Finance, Lancaster University.
This paper investigates the impact on option prices of divergent consumer confidence. To model this, we assume that consumers disagree on the expected growth rate of aggregate consumption. With other conditions unchanged in the discrete-time Black-Scholes option-pricing model, we show that the representative consumer will have declining relative risk aversion instead of the assumed constant relative risk aversion. In this case all options will be underpriced by the Black-Scholes model under the assumption of bivariate lognormality. We also extend Benninga and Mayshars (2000) results about impact on option prices of heterogeneous beliefs and preferences to an N-agent economy.
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