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The limitation of monotonicity property of option prices: an empirical evidence

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  • Chuang Yuang Lin
  • Dar Hsin Chen
  • Chin Yu Tsai
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    Abstract

    Many option pricing models are based on the assumption that the underlying asset price follows one-dimensional diffusion process. An alternative approach is to test the properties that should hold for all models based on a given stochastic process for the underlying asset. Following Perignon (2006), we test the empirical validity of the monotonicity property for option prices by collecting all transaction data from 1 July 2006 to 31 December 2006 for option contracts traded on the Taiwan Futures Exchange (TAIFEX). We find that sampled intraday option prices violate the monotonicity property between 29.97% and 57% of the time, and that call and put prices often increase, or decrease, together. We also find evidence to show that the frequent violations of the monotonicity property are to a large extent attributable to microstructure effects and that they arise from rational trading tactics.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/00036840903427265
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Economics.

    Volume (Year): 43 (2011)
    Issue (Month): 23 ()
    Pages: 3103-3113

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    Handle: RePEc:taf:applec:v:43:y:2011:i:23:p:3103-3113

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