Journal Article

Options Trading and the CAPM

Joel M. Vanden

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 17, issue 1, pages 207-238
Published in print January 2004 | ISSN: 0893-9454
Published online January 2004 | e-ISSN: 1465-7368 | DOI: http://dx.doi.org/10.1093/rfs/hhg026
Options Trading and the CAPM

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This article studies equilibrium asset pricing when agents face nonnegative wealth constraints. In the presence of these constraints it is shown that options on the market portfolio are nonredundant securities and the economy's pricing kernel is a function of both the market portfolio and the nonredundant options. This implies that the options should be useful for explaining risky asset returns. To test the theory, a model is derived in which the expected excess return on any risky asset is linearly related (via a collection of betas) to the expected excess return on the market portfolio and to the expected excess returns on the nonredundant options. The empirical results indicate that the returns on traded index options are relevant for explaining the returns on risky asset portfolios.

Journal Article.  13444 words.  Illustrated.

Subjects: Financial Markets

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