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Derivatives traders’ reaction to mispricing in the underlying equity

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  • Hayunga, Darren K.
  • Holowczak, Richard D.
  • Lung, Peter P.
  • Nishikawa, Takeshi
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    Abstract

    This article examines trading behavior in the options market conditioned on mispricing in the underlying stock. We investigate the price equilibrium between the observed equity asset and the options-implied synthetic share as well as the relative divergence between the two prices. We find a consistently positive relation between the level of stock mispricing and violations of the upper-boundary condition using derivatives, along with an increase in price divergence. To control for the effect of shorting limitations on mispricing, we further examine prices during the short-sale ban in 2008. The results hold and in many instances are more significant during the ban period. Given the persistent disequilibria between the synthetic and observed stock prices, we argue the results are evidence of informed trading in the derivatives market.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 36 (2012)
    Issue (Month): 9 ()
    Pages: 2438-2454

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    Handle: RePEc:eee:jbfina:v:36:y:2012:i:9:p:2438-2454

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Asset pricing; Mispricing; Options; Information content; Price equilibrium;

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    References

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    Cited by:
    1. Ovidiu TURCOANE, 2012. "Option Price Estimations and Speculative Trading In Knowledge Society," Informatica Economica, Academy of Economic Studies - Bucharest, Romania, vol. 16(4), pages 131-141.

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