Call options and the risk of underlying securities

Ravi Jagannathan*

*Corresponding author for this work

Research output: Contribution to journalArticle

39 Scopus citations

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 'riskness' 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.

Original languageEnglish (US)
Pages (from-to)425-434
Number of pages10
JournalJournal of Financial Economics
Volume13
Issue number3
DOIs
StatePublished - Sep 1984

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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