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Uncertainty measure: As a proxy for the degree of market imperfection

Author

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  • Zhang, Hailiang
  • Sattar, Muhammad Atif
  • Wang, Haijun

Abstract

This study makes a significant contribution to the existing literature on the concept of the “degree of imperfection between markets” and its evaluation model, which was originally developed by Wang and Hsu in 2004. By further expanding upon this foundational framework, Hsu (2010) established that the degree of imperfection between markets also applies within a market and can be operationalized in option markets. With these insights as a basis, this study formulates hypotheses to examine the relationship between the degree of imperfection and three key variables: the absolute error (AE) of call prices, the absolute error (AE) of implied volatility, and uncertainty. The empirical results of the hypothesis reveal a positive association between the degree of imperfection and the AE of call price, AE of implied volatility, and uncertainty. Moreover, the Study introduces Shannon entropy as a measure of uncertainty, and establishes uncertainty as a viable proxy for quantifying the degree of imperfection.

Suggested Citation

  • Zhang, Hailiang & Sattar, Muhammad Atif & Wang, Haijun, 2024. "Uncertainty measure: As a proxy for the degree of market imperfection," International Review of Economics & Finance, Elsevier, vol. 89(PB), pages 159-171.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pb:p:159-171
    DOI: 10.1016/j.iref.2023.09.013
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