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RFS Advance Access published online on August 11, 2003
Review of Financial Studies, doi:10.1093/rfs/hhg026
Review of Financial Studies © The Society for Financial Studies 2003; all rights reserved
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© 2003 The Society for Financial Studies

Original Articles

Options Trading and the CAPM

Joel M. Vanden 1*
1 Tuck School of Business, Dartmouth College, Hanover, NH 03755-9022

* To whom correspondence should be addressed. E-mail: joel.vanden{at}dartmouth.edu.


  Abstract

This article studies equilibrium asset pricing when agents face non-negative wealth constraints. In the presence of these constraints it is shown that options on the market portfolio are non-redundant securities and the economy's pricing kernel is a function of both the market portfolio and the non-redundant 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 non-redundant options. The empirical results indicate that the returns on traded index options are relevant for explaining the returns on risky asset portfolios.


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J. M. Vanden
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