TY  - JOUR
AU  - Garleanu,Nicolae
AU  - Pedersen,Lasse Heje
AU  - Poteshman,Allen M.
TI  - Demand-Based Option Pricing
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 11843
PY  - 2005
Y2  - December 2005
UR  - http://www.nber.org/papers/w11843
L1  - http://www.nber.org/papers/w11843.pdf
N1  - Author contact info:
Nicolae B. Garleanu
Haas School of Business
F628
University of California, Berkeley
Berkeley, CA 94720
Tel: (1) 510 642 3421
Fax: (1) 510 643 1420
E-Mail: garleanu@haas.berkeley.edu

Lasse H. Pedersen
NYU Stern Finance
44 West Fourth Street
Suite 9-190
New York, NY 10012
Tel: 212/998-0359
Fax: 212/995-4233
E-Mail: lpederse@stern.nyu.edu

Allen Poteshman
D.E. Shaw & Co.
39th Floor, Tower 45
120 West Forty-Fifth Street
New York, NY  10036
Tel: (217) 778-6064
E-Mail: poteshman@gmail.com
AB  - We model the demand-pressure effect on prices when options cannot be perfectly hedged. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects help explain well-known option-pricing puzzles. First, end users are net long index options, especially out-of-money puts, which helps explain their apparent expensiveness and the smirk. Second, demand patterns help explain the prices of single-stock options.
ER  -