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Option Market Microstructure and Stochastic Volatility

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Author Info
Doug Steigerwald (University of California, Santa Barbara)
Richard Vagnoni (General Accounting Office, Washington D.C.)

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Abstract

Our primary goal is to develop and analyze a dynamic economic model that takes into account several sources of information-based trade the markets for a stock and options on that stock and that ultimately accounts for salient features of stock price data, including serial correlation in stock trades, serial correlation in squared stock price changes (stochastic volatility), and more persistent serial correlation in stock trades than in squared stock price changes. We derive the dynamic relationships among the stock, the call option, and the put option and capture the leverage effect offered by options. We derive consistency results for the learning process and the convergence of an assets quotes to the assets true value. We also derive closed-form analytic results for expected calendar period price changes and trades, and we examine calendar period serial correlation properties of squared price changes and trades.

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Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number 17-01.

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Date of creation: 28 Aug 2001
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Handle: RePEc:cdl:ucsbec:17-01

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Related research
Keywords: Market; Microstructure; Stochastic; Volatility;

References listed on IDEAS
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  1. Harris, Milton & Raviv, Artur, 1993. "Differences of Opinion Make a Horse Race," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(3), pages 473-506. [Downloadable!] (restricted)
  2. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November. [Downloadable!] (restricted)
  3. David Easley & Maureen O'Hara & P.S. Srinivas, 1998. "Option Volume and Stock Prices: Evidence on Where Informed Traders Trade," Journal of Finance, American Finance Association, vol. 53(2), pages 431-465, 04. [Downloadable!] (restricted)
  4. Harris, Lawrence, 1987. "Transaction Data Tests of the Mixture of Distributions Hypothesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 127-141, June. [Downloadable!]
  5. Andersen, Torben G, 1996. " Return Volatility and Trading Volume: An Information Flow Interpretation of Stochastic Volatility," Journal of Finance, American Finance Association, vol. 51(1), pages 169-204, March. [Downloadable!] (restricted)
  6. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  7. French, Kenneth R. & Roll, Richard, 1986. "Stock return variances : The arrival of information and the reaction of traders," Journal of Financial Economics, Elsevier, vol. 17(1), pages 5-26, September. [Downloadable!] (restricted)
  8. Garman, Mark B., 1976. "Market microstructure," Journal of Financial Economics, Elsevier, vol. 3(3), pages 257-275, June. [Downloadable!] (restricted)
  9. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1997. "One Day in the Life of a Very Common Stock," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(3), pages 805-35.
  10. Easley, David & O'Hara, Maureen, 1987. "Price, trade size, and information in securities markets," Journal of Financial Economics, Elsevier, vol. 19(1), pages 69-90, September. [Downloadable!] (restricted)
  11. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March. [Downloadable!] (restricted)
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