Option Pricing Model Based On Cumulative Prospect Theory And Mental Accounting

As an important financial derivative, option pricing problem is the key of financial derivative pricing research. On the premise of efficient market and rational man hypothesis, traditional option pricing model ignores the influence of various friction, investors’ risk attitude and incomplete information in the investment process, so that cannot simulate and predict the option price effectively. Along with the appearance of financial anomalies and non rational investors empirical test, behavior finance put forward that investors’ psychological activity plays a crucial role in the investment philosophy, investment decision and market pricing. Under this background, the focus of option pricing turn to research the behavior of investors’ decision-making from the perspective of psychology. The current study shows that, applied the cumulative prospect theory and mental accounting to the option pricing can significantly improve the accuracy of traditional option pricing model. However, the existing research mostly focuses on the theoretical analysis and numerical simulation, which lack of empirical support. And, with the foundation and development the option market of our country, the significance of study option pricing from the perspective of behavioral finance cannot be ignored.Firstly, this paper analyzes the research background, the significance and the domestic and foreign literature review of the option pricing model based on cumulative prospect theory and mental accounting. Secondly, elaborates two important components of behavioral finance:cumulative prospect theory and mental accounting theory. Thirdly, under the framework of mental accounting, use the value function and decision weighting function of cumulative prospect theory to substitute the risk neutral hypothesis of traditional option pricing model, and summarizes the option pricing model based on cumulative prospect theory and mental accounting.At the empirical analysis section, this paper uses the transaction data of HSI call options to inspect the rationality of the option pricing model based on cumulative prospect theory and mental accounting. From the comparison of estimation errors of population, different expiration date and different moneyness degree in three models, the results prove that option pricing model based on cumulative prospect theory and mental accounting performed significantly better than the Black-Scholes model and CRR model in the overall estimation error, the medium-term option, OTM and parity option.