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Does it Pay to Be an Optimist?

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  • Paul Schneider

    (University of Lugano and Swiss Finance Institute)

Abstract

This paper develops an equilibrium model of a market, where a pessimist, an optimist, and a pragmatist trade option portfolios with each other. Incompleteness allows them to form different opinions on the underlying distributions, while fundamental prices remain within bid ask bounds. An application of the model to S&P 500 options data shows that the agents use different and surprisingly small representative state spaces of the underlying. The pessimist and the pragmatist sell variance swaps, commonly perceived to be an insurance instrument, whereas the optimist buys them. Robustly to changes in the input parameters and variations in the setup, such as noise trading and learning, the pessimist is the most successful agent, while the optimist loses consistently. Belief dispersion predicts actual trading volume and open interest.

Suggested Citation

  • Paul Schneider, 2018. "Does it Pay to Be an Optimist?," Swiss Finance Institute Research Paper Series 18-02, Swiss Finance Institute, revised Feb 2018.
    • Handle: RePEc:chf:rpseri:rp1802
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    Cited by:

    1. Fousseni Chabi-Yo & Chukwuma Dim & Grigory Vilkov, 2023. "Generalized Bounds on the Conditional Expected Excess Return on Individual Stocks," Management Science, INFORMS, vol. 69(2), pages 922-939, February.
    2. Branger, Nicole & Konermann, Patrick & Schlag, Christian, 2019. "Optimists and pessimists in (in)complete markets," SAFE Working Paper Series 252, Leibniz Institute for Financial Research SAFE.

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