Working Paper: NBER ID: w23708
Authors: George M. Constantinides; Michal Czerwonko; Stylianos Perrakis
Abstract: The optimal portfolio of a utility-maximizing investor trading in the S&P 500 index and cash, subject to proportional transaction costs, becomes stochastically dominated when overlaid with a zero-net-cost portfolio of S&P 500 options bought at their ask and written at their bid price in most months over 1990-2013. Dominance is prevalent when the ATM-IV is high, right skew is low, and option maturity is short. The portfolios include mostly calls and positions are overwhelmingly short. Similar results obtain with options on the CAC and DAX indices. The results are explained neither by priced factors nor a non-monotonic stochastic discount factor.
Keywords: options; portfolio optimization; stochastic dominance; mispricing
JEL Codes: G10; G11; G13; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| zero-net-cost portfolio (OT) (G19) | original index portfolio (IT) (G11) |
| zero-net-cost portfolio (OT) (G19) | expected utility (D81) |
| zero-net-cost portfolio (OT) (G19) | income shift from states of high index levels to states of low index levels (H73) |
| zero-net-cost portfolio (OT) (G19) | utility of any risk-averse investor holding the underlying index and risk-free asset (G19) |
| zero-net-cost portfolio (OT) (G19) | excess returns (D46) |