Working Paper: NBER ID: w16302
Authors: George M. Constantinides; Michal Czerwonko; Jens Carsten Jackwerth; Stylianos Perrakis
Abstract: American options on the S&P 500 index futures that violate the stochastic dominance bounds of Constantinides and Perrakis (2007) from 1983 to 2006 are identified as potentially profitable trades. Call bid prices more frequently violate their upper bound than put bid prices do, while violations of the lower bounds by ask prices are infrequent. In out of sample tests of stochastic dominance, the writing of options that violate the upper bound increases the expected utility of any risk averse investor holding the market and cash, net of transaction costs and bid ask spreads. The results are economically significant and robust.
Keywords: Options; Index Futures; Risk Averse Investors; Stochastic Dominance
JEL Codes: D53; G11; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| writing options that violate the upper stochastic dominance bounds (C69) | increases the expected utility of risk-averse investors (D11) |
| the return of an option writer (G13) | stochastically dominates the return of an index trader who does not trade options (C69) |
| violations of the call upper bound (P37) | lead to a superior trading strategy (G11) |
| exploiting violations of the upper stochastic dominance bounds (D81) | enhances portfolio returns (G11) |