Related media
Research
Preprint
Option Pricing with Rational Inattention
Social Science Research Network (SSRN) , Vol.10 March 2025
Elsevier
2025
Abstract
It is now well-established that attention is a limited resource. However, is it possible to adjust option pricing models for limited attention in such a manner that they retain their practical value? By using recent findings from the brain sciences, this article shows that accounting for limited attention is surprisingly straightforward and only requires replacing the risk-free rate with a higher rate in the call option formula and with a lower rate in the put option formula, with the exact rate depending on the attention parameter that takes values between zero and one. This simple modification generates prices within the no-arbitrage bounds, and demonstrates how limited attention contributes to various option pricing puzzles. Calibration exercise with the S&P 500 index options shows that the attention parameter takes values in line with prior empirical research while delivering a substantial improvement in model fit.
Details
- Title
- Option Pricing with Rational Inattention
- Authors
- Hammad Siddiqi (Author) - University of the Sunshine Coast
- Publication details
- Social Science Research Network (SSRN) , Vol.10 March 2025
- Publisher
- Elsevier
- Date published
- 2025
- DOI
- 10.2139/ssrn.5172077
- ISSN
- 1556-5068
- Organisation Unit
- School of Business and Creative Industries
- Language
- English
- Record Identifier
- 991243799802621
- Output Type
- Preprint
Metrics
1 Record Views