IDEAS home Printed from https://ideas.repec.org/p/zbw/upadbr/b3519.html
   My bibliography  Save this paper

How dynamic hedging affects stock price movements: Evidence from German option and certificate markets

Author

Listed:
  • Fischer, Georg

Abstract

We examine the impact of dynamic hedging demand of German option and discount certificate markets on the autocorrelation of German stock price changes. We theoretically model the demand of liquidity providers in the discount certificate market, a structured financial product with a concave payoff profile, asking whether dynamic hedging by certificate issuers induces negative return autocorrelation in stock markets. We find empirical evidence that the hedging demand of option issuers has a positive impact on return autocorrelation, while the opposite holds for certificate issuers, whose hedging demand enhances the negative return autocorrelation in the stock market. We thus theoretically and empirically provide evidence that there are persistent spillover effects from option and certificate markets to stock markets due to dynamic hedging activities.

Suggested Citation

  • Fischer, Georg, 2019. "How dynamic hedging affects stock price movements: Evidence from German option and certificate markets," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe B-35-19, University of Passau, Faculty of Business and Economics.
    • Handle: RePEc:zbw:upadbr:b3519
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/191642/1/1047625016.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Kleibergen, Frank & Paap, Richard, 2006. "Generalized reduced rank tests using the singular value decomposition," Journal of Econometrics, Elsevier, vol. 133(1), pages 97-126, July.
    2. Johnson, Travis L. & So, Eric C., 2012. "The option to stock volume ratio and future returns," Journal of Financial Economics, Elsevier, vol. 106(2), pages 262-286.
    3. Leland, Hayne E, 1985. "Option Pricing and Replication with Transactions Costs," Journal of Finance, American Finance Association, vol. 40(5), pages 1283-1301, December.
    4. Richard B. Olsen & Ulrich A. Müller & Michel M. Dacorogna & Olivier V. Pictet & Rakhal R. Davé & Dominique M. Guillaume, 1997. "From the bird's eye to the microscope: A survey of new stylized facts of the intra-daily foreign exchange markets (*)," Finance and Stochastics, Springer, vol. 1(2), pages 95-129.
    5. U. Çetin & R. Jarrow & P. Protter & M. Warachka, 2008. "Pricing Options in an Extended Black Scholes Economy with Illiquidity: Theory and Empirical Evidence," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 9, pages 185-221, World Scientific Publishing Co. Pte. Ltd..
    6. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    7. John Y. Campbell & Sanford J. Grossman & Jiang Wang, 1993. "Trading Volume and Serial Correlation in Stock Returns," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 108(4), pages 905-939.
    8. Greenwood, Robin, 2005. "Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage," Journal of Financial Economics, Elsevier, vol. 75(3), pages 607-649, March.
    9. Jun Pan & Allen M. Poteshman, 2006. "The Information in Option Volume for Future Stock Prices," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 871-908.
    10. Toda, Hiro Y. & Yamamoto, Taku, 1995. "Statistical inference in vector autoregressions with possibly integrated processes," Journal of Econometrics, Elsevier, vol. 66(1-2), pages 225-250.
    11. Nicolas P. B. Bollen & Robert E. Whaley, 2004. "Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?," Journal of Finance, American Finance Association, vol. 59(2), pages 711-753, April.
    12. Whitney K. Newey & Kenneth D. West, 1994. "Automatic Lag Selection in Covariance Matrix Estimation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 61(4), pages 631-653.
    13. Dietmar Leisen & Matthias Reimer, 1996. "Binomial models for option valuation - examining and improving convergence," Applied Mathematical Finance, Taylor & Francis Journals, vol. 3(4), pages 319-346.
    14. Bruce N. Lehmann, 1990. "Fads, Martingales, and Market Efficiency," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 105(1), pages 1-28.
    15. Svensson, Lars E O, 1994. "Estimating and Interpreting Forward Interest Rates: Sweden 1992-4," CEPR Discussion Papers 1051, C.E.P.R. Discussion Papers.
    16. Rainer Baule & Oliver Entrop & Marco Wilkens, 2008. "Credit risk and bank margins in structured financial products: Evidence from the German secondary market for discount certificates," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(4), pages 376-397, April.
    17. Doron Avramov & Tarun Chordia & Amit Goyal, 2006. "Liquidity and Autocorrelations in Individual Stock Returns," Journal of Finance, American Finance Association, vol. 61(5), pages 2365-2394, October.
    18. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    19. Cragg, John G. & Donald, Stephen G., 1993. "Testing Identifiability and Specification in Instrumental Variable Models," Econometric Theory, Cambridge University Press, vol. 9(2), pages 222-240, April.
    20. A. E. Whalley & P. Wilmott, 1997. "An Asymptotic Analysis of an Optimal Hedging Model for Option Pricing with Transaction Costs," Mathematical Finance, Wiley Blackwell, vol. 7(3), pages 307-324, July.
    21. Svensson, L.E.O., 1994. "Estimating and Interpreting Foreward Interest Rates: Sweden 1992-1994," Papers 579, Stockholm - International Economic Studies.
    22. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-489, October.
    23. Hu, Jianfeng, 2014. "Does option trading convey stock price information?," Journal of Financial Economics, Elsevier, vol. 111(3), pages 625-645.
    24. Shleifer, Andrei, 1986. "Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-590, July.
    25. T. Clifton Green & Stephen Figlewski, 1999. "Market Risk and Model Risk for a Financial Institution Writing Options," Journal of Finance, American Finance Association, vol. 54(4), pages 1465-1499, August.
    26. Jeffrey Wurgler & Ekaterina Zhuravskaya, 2002. "Does Arbitrage Flatten Demand Curves for Stocks?," The Journal of Business, University of Chicago Press, vol. 75(4), pages 583-608, October.
    27. A.E. Whalley & P. Wilmott, 1999. "Optimal Hedging of Options with Small but Arbitrary Transaction Cost Structure," OFRC Working Papers Series 1999mf09, Oxford Financial Research Centre.
    28. Boyle, Phelim P & Vorst, Ton, 1992. "Option Replication in Discrete Time with Transaction Costs," Journal of Finance, American Finance Association, vol. 47(1), pages 271-293, March.
    29. Baule, Rainer, 2011. "The order flow of discount certificates and issuer pricing behavior," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3120-3133, November.
    30. Harrison Hong & Jeremy C. Stein, 1999. "A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets," Journal of Finance, American Finance Association, vol. 54(6), pages 2143-2184, December.
    31. Chakrabarty, Bidisha & Li, Bingguang & Nguyen, Vanthuan & Van Ness, Robert A., 2007. "Trade classification algorithms for electronic communications network trades," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3806-3821, December.
    32. Ellis, Katrina & Michaely, Roni & O'Hara, Maureen, 2000. "The Accuracy of Trade Classification Rules: Evidence from Nasdaq," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(4), pages 529-551, December.
    33. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    34. Roll, Richard, 1984. "A Simple Implicit Measure of the Effective Bid-Ask Spread in an Efficient Market," Journal of Finance, American Finance Association, vol. 39(4), pages 1127-1139, September.
    35. 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, April.
    36. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Entrop, Oliver & Fischer, Georg, 2019. "Hedging costs and joint determinants of premiums and spreads in structured financial products," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe B-34-19, University of Passau, Faculty of Business and Economics.
    2. Oliver Entrop & Georg Fischer, 2020. "Hedging costs and joint determinants of premiums and spreads in structured financial products," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(7), pages 1049-1071, July.
    3. Lin, Zih-Ying & Chang, Chuang-Chang & Wang, Yaw-Huei, 2018. "The impacts of asymmetric information and short sales on the illiquidity risk premium in the stock option market," Journal of Banking & Finance, Elsevier, vol. 94(C), pages 152-165.
    4. Peter Christoffersen & Ruslan Goyenko & Kris Jacobs & Mehdi Karoui, 2018. "Illiquidity Premia in the Equity Options Market," Review of Financial Studies, Society for Financial Studies, vol. 31(3), pages 811-851.
    5. Baule, Rainer & Münchhalfen, Patrick & Shkel, David & Tallau, Christian, 2023. "Fair-washing in the market for structured retail products? Voluntary self-regulation versus government regulation," Journal of Banking & Finance, Elsevier, vol. 148(C).
    6. Gkionis, Konstantinos & Kostakis, Alexandros & Skiadopoulos, George & Stilger, Przemyslaw S., 2021. "Positive stock information in out-of-the-money option prices," Journal of Banking & Finance, Elsevier, vol. 128(C).
    7. Kanne, Stefan & Korn, Olaf & Uhrig-Homburg, Marliese, 2016. "Stock Illiquidity, option prices, and option returns," CFR Working Papers 16-08, University of Cologne, Centre for Financial Research (CFR).
    8. Kanne, Stefan & Korn, Olaf & Uhrig-Homburg, Marliese, 2023. "Stock illiquidity and option returns," Journal of Financial Markets, Elsevier, vol. 63(C).
    9. Chin‐Ho Chen, 2021. "Investor sentiment, misreaction, and the skewness‐return relationship," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(9), pages 1427-1455, September.
    10. Atmaz, Adem & Basak, Suleyman, 2019. "Option prices and costly short-selling," Journal of Financial Economics, Elsevier, vol. 134(1), pages 1-28.
    11. Andrea Schertler & Saskia Stoerch, 2018. "Warrant price responses to credit spread changes: Fact or fiction?," Review of Financial Economics, John Wiley & Sons, vol. 36(3), pages 206-219, July.
    12. Entrop, Oliver & Fischer, Georg & McKenzie, Michael & Wilkens, Marco & Winkler, Christoph, 2016. "How does pricing affect investors’ product choice? Evidence from the market for discount certificates," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 195-215.
    13. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, November.
    14. Vinay Patel, 2015. "Price Discovery in US and Australian Stock and Options Markets," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 27, July-Dece.
    15. Yi‐Wei Chuang & Wei‐Che Tsai & Ming‐Hung Wu, 2020. "The impact of net buying pressure on VIX option prices," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(2), pages 209-227, February.
    16. Huh, Sahn-Wook & Lin, Hao & Mello, Antonio S., 2015. "Options market makers׳ hedging and informed trading: Theory and evidence," Journal of Financial Markets, Elsevier, vol. 23(C), pages 26-58.
    17. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    18. Schertler, Andrea, 2016. "Pricing effects when competitors arrive: The case of discount certificates in Germany," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 84-99.
    19. Augustin, Patrick & Brenner, Menachem & Grass, Gunnar & Subrahmanyam, Marti G., 2016. "How do insiders trade?," CFS Working Paper Series 541, Center for Financial Studies (CFS).
    20. Jie Cao & Amit Goyal & Xiao Xiao & Xintong Zhan, 2023. "Implied Volatility Changes and Corporate Bond Returns," Management Science, INFORMS, vol. 69(3), pages 1375-1397, March.

    More about this item

    Keywords

    Structured products; Derivatives; Dynamic hedging; Stock return autocorrelation; Market microstructure;
    All these keywords.

    JEL classification:

    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:upadbr:b3519. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: https://edirc.repec.org/data/fwpasde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.