Learning and Index Option Returns

ABSTRACT

Little is known about the economic sources that may generate the abnormal returns observed in put index options. We show that the learning process followed by investors may be one such source. We develop an equilibrium model under partial information in which a rational Bayesian learner prices put option contracts. Our model generates put option returns similar to the empirical returns of S&P 500 put index options. This result is not obtained when we analyze alternative setups of the model in which no learning process exists.

KEY WORDS:

• Put option returns
• Equilibrium model
• Partial information
• Learning
• Structural breaks.

ACKNOWLEDGMENTS

We are grateful to Rong Chen and Todd Clark (the Editors), one Associate Editor and two anonymous referees for their stimulating, thorough, and constructive comments. We would like to thank Xiaohua Chen, Massimo Guidolin, Christian Hellwig, Eduardo Rodriguez, Marcela Valenzuela, Patricio Valenzuela, Thanos Verousis and seminar participants in the Pontificia Universidad Católica de Chile, Universidad de Chile and Banque de France for their comments on earlier versions of this paper. We are also thankful to Vincent Guegan for the IT support. Alejandro Bernales acknowledges financial support from the Institute for Research in Market Imperfections and Public Policy (ICM IS130002). Financiado por la Vicerrectoría de Investigación y Desarrollo (VID) de la Universidad de Chile (ENL13/18). All remaining errors are ours.