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Psychological studies on decision making under uncertainty, which have been inspired by Kahneman and Tversky's study, have attracted considerable interest in financial research as key factors to solve anomalies that cannot be explained by the traditional models. Recently, we proposed an agent-based prospect theoretical model and demonstrated that the loss-aversion feature of investors is capable of explaining a large number of financial stylized facts. This paper aims to extend the previous work to the field of option pricing. Two important anomalies in the field-the implied volatility smile and the skewness premium-will be analyzed. This paper can be considered as an attempt to integrate the behavioral financial theory and the option pricing theory by using the agent-based approach.
Date of Publication: Oct. 2009