This paper proposes a framework which is compliant with complex real-world market characteristics for constructing subspaces within which lie investors compelled to take long positions, take short positions, or stand on the sidelines. To begin, I outline the relevant complex elements of securities markets. First, it is proposed that the market is not homogenous; the market is made up of many independent investors, each with their unique perspectives, forecasts, and levels of conviction. Second, it is proposed that investors are not risk neutral and have non-linear utility functions; the paper borrows an established utility function from behavioral finance. Third, it is shown that most market participants find an asset’s price too high to buy and too low to short; an effective asset pricing framework must acknowledge this. Fourth, it is proposed that options prices better reflect the sentiment of those who do not invest than they reflect the sentiment of those who do invest. The framework can use a single option price to create short put and long put frontier curves which carve up the two-dimensional investor space (x = expected value of underlying at expiration, y = uncertainty of this expected value) into three subspaces – investor buys, investor sells, and investor does nothing. When incorporating prices of multiple options on the same underlying asset with the same expiration date, the paper shows that the price curves intersect at a “knot”; the short put knot and long put frontier curves narrow in on the median investor’s expected return of the underlying asset.
JEL code.G12