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Call Options and the Risk of Underlying Securities, Journal of Financial Economics

Abstract

Merton (1973) in his seminal article Theory of Rational Option Pricing showed that the rationally determined price of a call option is a non-decreasing function of the riskiness of its associated common stock. In deriving his results, Merton made restrictive assumptions about the way the market prices payoff distributions, and used the Rothschild-Stiglitz (1970) measure to compare the riskiness of securities. I show by means of an example that the Merton result will not in general be true. I then derive a sufficient condition for the option on one stock to have higher market value than the option on another stock, when both the stocks have the same price, and explain why the Merton result is valid in the Black-Scholes environment.

Type

Article

Author(s)

Ravi Jagannathan

Date Published

1984

Citations

Jagannathan, Ravi. 1984. Call Options and the Risk of Underlying Securities. Journal of Financial Economics. 13(3): 425-434.

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