Option prices are set entirely by arbitrage, independent of risk attitudes or probabilities

Evidence

In Sharpe’s binomial model, an option can be hedged perfectly, just as in the Black-Scholes-Merton model. The theoretical price of an option is then determined, as in the Black-Scholes-Merton analysis, by the argument that a perfectly hedged portfolio must earn the riskless rate of interest. If the market price of an option deviates from that theoretical price, arbitrage is possible. Investors’ attitudes to risk need not be considered, and there is no need to know the probabilities that the stock will move “up” or “down” in price. It is arbitrage, not those probabilities or investors’ beliefs about them, that determines the price of an option. — Donald MacKenzie, An Engine, Not a Camera, 608

Categorization

• XREF: The antithesis of mainstream expected-return asset pricing; relevant to the book’s performativity thesis about how models constitute markets. — connects to: The option price is independent of the stock’s expected return. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 582; Risk-neutral valuation yields the identical option price as arbitrage arguments — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1285; Modern options pricing derives from arbitrage logic, not directional beliefs. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1454 (+3 more)

Broader Connections

• Modern options pricing derives from arbitrage logic, not directional beliefs. #corroborates (0.95) — Donald MacKenzie, An Engine, Not a Camera, 1454
• Risk-neutral valuation yields the identical option price as arbitrage arguments #corroborates (0.90) — Donald MacKenzie, An Engine, Not a Camera, 1285
• The arbitrage argument produces the Black-Scholes partial differential equation. #expands (0.90) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 95
• Pricing under a risk-neutrality fiction yields the same option price as arbitrage pricing. #qualifies (0.85) — Donald MacKenzie, An Engine, Not a Camera, 1283
• Market arbitrage requires only that investors prefer more wealth to less, not risk preferences #expands (0.80) — Donald MacKenzie, An Engine, Not a Camera, 180