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Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing

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  • Jameson, Mel
  • Wilhelm, William
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    Abstract

    In this paper, the authors provide empirical evidence consistent with the hypothesis that options market makers face risks in managing inventory that are unique to the options market. In particular, they show that risks associated with the inability to rebalance an option position continuously and uncertainty about the return volatility of the underlying stock each account for a statistically and economically significant proportion of the bid-ask spreads quoted for a sample of Chicago Board Options Exchange options. Copyright 1992 by American Finance Association.

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    Bibliographic Info

    Article provided by American Finance Association in its journal Journal of Finance.

    Volume (Year): 47 (1992)
    Issue (Month): 2 (June)
    Pages: 765-79

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    Handle: RePEc:bla:jfinan:v:47:y:1992:i:2:p:765-79

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    Cited by:
    1. Wu, Wei-Shao & Liu, Yu-Jane & Lee, Yi-Tsung & Fok, Robert C.W., 2014. "Hedging costs, liquidity, and inventory management: The evidence from option market makers," Journal of Financial Markets, Elsevier, vol. 18(C), pages 25-48.
    2. John Kambhu, 1997. "Interest rate options dealers' hedging in the US dollar fixed income market," Research Paper 9719, Federal Reserve Bank of New York.
    3. Pirjetä, Antti & Ikäheimo, Seppo & Puttonen, Vesa, 2010. "Market pricing of executive stock options and implied risk preferences," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 394-412, June.
    4. Saikat Nandi, 1995. "Asymmetric information about volatility and option markets," Working Paper 95-19, Federal Reserve Bank of Atlanta.
    5. Cao, Jie & Han, Bing, 2013. "Cross section of option returns and idiosyncratic stock volatility," Journal of Financial Economics, Elsevier, vol. 108(1), pages 231-249.
    6. John E. Kambhu, 1998. "Dealers' hedging of interest rate options in the U.S. dollar fixed-income market," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 35-58.
    7. Sasha Stoikov & Mehmet Sağlam, 2009. "Option market making under inventory risk," Review of Derivatives Research, Springer, vol. 12(1), pages 55-79, April.

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