Fahlenbrach, Rudiger (Ohio State U) Sandas, Patrik (U of Pennsylvania)
Abstract
A call option price is always an increasing and convex function of the underlying asset price whenever the underlying asset price follows a diffusion whose volatility depends only on time and the concurrent asset price-a one-dimensional diffusion. We empirically examine how often the observed quote movements are anomalous in the sense that they imply a violation of either the monotonicity or the convexity property using a sample of quotes and trades of options and futures on the FTSE 100 stock index. We show that such anomalous co-movements are about four times more likely to occur within a minute of an option trade than at other times and are related to the traders' order submissions. We interpret our results as evidence that the seemingly anomalous quote co-movements are driven by market frictions and should not be taken as evidence against option pricing models in the one-dimensional diffusion family. We show that the seemingly anomalous quote co-movements are consistent with traders making rational order submission decisions.
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Publisher Info
Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number
2005-10.
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Find related papers by JEL classification: C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data
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