Risk Aversion, Intertemporal Substitution, and Option Pricing

This paper develops a general stochastic framework and an equilibrium asset pricing model that make clear how attitudes towards intertemporal substitution and risk matter for option pricing. In particular, we show under which statistical conditions option pricing formulas are not preference-free, in other words when preferences are not hidden in the stock and bond prices as they are in the standard Black and Scholes (BS) or Hull and White (HW) pricing formulas.