Boryana Racheva-Iotova, co-founder of FinAnalytica, is Senior Vice-President for Risk and Quantitative Analytics at FactSet. She has over 15 years of experience in building quantitative portfolio management software solutions. Before founding FinAnalytica, Boryana led the implementation of a Monte-Carlo based VaR-framework for Basel II at SGZ-Bank, and development six patented methodologies. In 2018, Boryana received Risk Professional of the Year Award from Waters Technology, WITAD, based on her achievements building risk management solutions and translating the latest academic advancements in practical applications to meet the needs of financial industry practitioners. Boryana holds Doctor of Science from Ludwig Maximilian University, Munich.
Market sentiment factors based on behavioural-based option pricing
We explain main concepts of Prospect Theory (PT) and Cumulative Prospect Theory (CPT) within the framework of the rational dynamic asset pricing theory. We discuss key requirements with respect to the CPT’s weighting function to preserve key characteristics of the price process essential for deducting derivatives pricing asset and solve general class of optimization problems. We provide an example when the asset returns are altered with a a modified Prelec’s weighting probability function. We introduce new parametric classes for Prospect Theory value functions and weighting probability functions consistent with rational dynamic pricing Theory and illustrate the concept by deriving market-sentiment measures based the options market. Practitioners could use such sentiment measures as new type of risk factors. The approach can also be used in more general optimization problem as a substitute for the empirical density as it derives the entire market-implied distribution.