Options Trading and the CAPM

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Abstract

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.

Original languageEnglish (US)
Pages (from-to)207-238
Number of pages32
JournalReview of Financial Studies
Volume17
Issue number1
DOIs
StatePublished - Jan 1 2004

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

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