Author: Young-Hye Cho
Publisher:
ISBN:
Category :
Languages : en
Pages : 46
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Book Description
In this paper, we examine the impact of market activity on the percentage bid-ask spreads of Samp;P 100 index options using transactions data. We propose a new market microstructure theory which we call derivative hedge theory, in which option market percentage spreads will be inversely related to the option market maker's ability to hedge his positions in the underlying market, as measured by the liquidity of the latter market. In a perfect hedge world, spreads arise from the illiquidity of the underlying market, rather than from inventory risk or informed trading in the option market itself. We find option market volume is not a significant determinant of option market spreads. This finding leads us to question the use of volume as a measure of liquidity and supports the derivative hedge theory. Option market spreads are positively related to spreads in the underlying market, again supporting our theory. However, option market duration does affect option market spreads, with very slow and very fast option markets both leading to bigger spreads. The fast market result would be predicted by the asymmetric information theory. Inventory model predicts big spreads in slow markets. Neither result would be observed if the underlying securities market provided a perfect hedge. We interpret these mixed results as meaning that the option market maker is able to only imperfectly hedge his positions in the underlying securities market. Our result of insignificant options volume casts doubt on the price discovery argument between stock and option market (Easley, O'Hara, and Srinivas (1998)). Asymmetric information costs in either market are naturally passed to the other market maker's hedgeing and therefore it is unimportant where the informed traders trade.
Author: Young-Hye Cho
Publisher:
ISBN:
Category : Hedging (Finance)
Languages : en
Pages : 56
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Book Description
In this paper, we examine the impact of market activity on the percentage bid-ask spreads of S & P 100 index options using transactions data. We propose a new market microstructure theory which we call derivative hedge theory, in which option market percentage spreads will be inversely related to the option market maker's ability to hedge his positions in the underlying market, as measured by the liquidity of the latter market. In a perfect hedge world, spreads arise from the illiquidity of the underlying market, rather than from inventory risk or informed trading in the option market itself. We find option market volume is not a significant determinant of option market spreads. This finding leads us to question the use of volume as a measure of liquidity and supports the derivative hedge theory. Option market spreads are positively related to spreads in the underlying market, again supporting our theory. However, option market duration does affect option market spreads, with very slow and very fast option markets both leading to bigger spreads. The fast market result would be predicted by the asymmetric information theory. Inventory model predicts big spreads in slow markets. Neither result would be observed if the underlying securities market provided a perfect hedge. We interpret these mixed results as meaning that the option market maker is able to only imperfectly hedge his positions in the underlying securities market. Our result of insignificant options volume casts doubt on the price discovery argument between stock and option market (Easley, O'Hara, and Srinivas (1998)). Asymmetric information costs in either market are naturally passed to the other market maker's hedgeing and therefore it is unimportant where the informed traders trade.
Author: Cho Young-Hye
Publisher:
ISBN:
Category :
Languages : en
Pages : 41
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Book Description
Author: Nicolas P. B. Bollen
Publisher:
ISBN:
Category :
Languages : en
Pages : 57
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Book Description
The need to understand and measure the determinants of market maker bid/ask spreads is crucial in evaluating the merits of competing market structures and the fairness of market maker rents. After providing a brief review of past work, this study develops a simple, parsimonious model for the market maker's spread that accounts for the effects of price discreteness induced by minimum tick size, order-processing costs, inventory-holding costs, adverse selection, and competition. The inventory-holding and adverse selection cost components of spread are modeled as an option with a stochastic time to expiration. This inventory-holding premium embedded in the spread represents compensation for the price risk borne by the market maker while the security is held in inventory. The premium is partitioned in such a way that the inventory holding and adverse selection cost components and the probability of an informed trade are identified. The model is tested empirically on a sample of NASDAQ stocks over three distinct tick size regimes and is shown to perform well.
Author: Tim Bollerslev
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
A probabilistic framework for the analysis of screen-based trading activity in financial markets is presented. Conditional probability functions are derived for the stationary distributions of the best bid and offer in the market, given the order flows and the acceptance rates of bids and offers. These flows are conditioned on observable screen information. A two-step method is developed for the estimation of the conditional probability functions. The estimation allows for the separate identification of the unobservable order and acceptance flows, which in turn may be used to predict the stationary distributions of the bid- ask spreads, transaction prices, and other market statistics. A formal comparison of the predicted and the sample bid-ask spread distribution provides a stringent test of the model. The necessary econometric methods for conducting such a test, taking into account the parameter estimation error uncertainty, is developed. The methodology is applied to the screen-based interbank foreign exchange market, using a newly available dataset that consists of continuously recorded bid and ask quotes on the Deutschemark/U.S. Dollar exchange rate. The model is found to provide a good description of the salient probabilistic features of the market structure, even though the formal prediction based test for the spread distribution, with more than 29,000 out-of-sample quotations, rejects the exact parametric formulation of the order flows.
Author: PeiLin Billy Hsieh
Publisher:
ISBN:
Category :
Languages : en
Pages : 61
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Book Description
This paper documents the fact that in options markets, the (percentage) implied volatility bid-ask spread increases at an increasing rate as the option's maturity date approaches. To explain this stylized fact, this paper provides a market microstructure model for the bid-ask spread in options markets. We first construct a static equilibrium model to illustrate the aforementioned phenomenon where risk averse and competitive option market makers quote bid and ask prices to minimize their inventory risk in an incomplete market with both directional and volatility risk. We extend this model to multi-periods and show that the same phenomenon occurs there as well. Two new implications are generated: a volatility level effect and a volatility variance effect. These implications are empirically tested, and the empirical results confirm the model's validity. Finally, we document the importance of de-trending the maturity effect by showing that the de-trended percentage volatility spread explains future jump intensities better than the original percentage volatility spread.
Author: Kevin T Webster
Publisher: CRC Press
ISBN: 1000877655
Category : Mathematics
Languages : en
Pages : 433
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Book Description
Builds a market simulator to back test trading algorithms Implements closed-form strategies that optimize trading signals Measures liquidity risk and stress test portfolios for fire sales Analyze algorithms’ performance controlling for common trading biases Estimates price impact models using the public trading tape
Author: Hans R. Stoll
Publisher:
ISBN:
Category : Business & Economics
Languages : en
Pages : 88
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Book Description
Author: Marco Klapper
Publisher: Anchor Academic Publishing (aap_verlag)
ISBN: 3954896729
Category : Business & Economics
Languages : en
Pages : 70
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Book Description
This study examines the kind of information ‘informed’ traders have prior to a takeover announcement using options of target firms and elaborates on the cross-sectional relationship between options and stocks around takeover announcements. Financial markets are driven by information and by individuals that generate, process, and disclose this information to the market. Naturally, there have to be individuals who possess more information about a firm or a future event than other market participants. Mergers and acquisitions are particularly interesting events in this regard because they can have significant implications for the firms and stakeholders involved, as well as for the competitive dynamics in the respective market. Because of the large potential price impact of such transactions, traders with private information about a prospective takeover are expected to trade on this information to make a profit. But who are these ‘informed traders’ and what kind of information do they possess? This study tries to give a respond to this question.
Author: Lars Nordén
Publisher:
ISBN:
Category :
Languages : en
Pages : 32
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