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Informed Trading in Stock and Option Markets

Author

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  • Sugato Chakravarty

    (Purdue University)

  • Huseyin Gulen
  • Stewart Mayhew

Abstract

We investigate the contribution of option markets to price discovery, using a modification of Hasbrouck's (1995) "information share" approach. Based on five years of stock and options data for 60 firms, we estimate the option market's contribution to price discovery to be about 17% on average. Option market price discovery is related to trading volume and spreads in both markets, and stock volatility. Price discovery across option strike prices is related to leverage, trading volume, and spreads. Our results are consistent with theoretical arguments that informed investors trade in both stock and option markets, suggesting an important informational role for options. Copyright 2004 by The American Finance Association.

Suggested Citation

  • Sugato Chakravarty & Huseyin Gulen & Stewart Mayhew, 2004. "Informed Trading in Stock and Option Markets," Journal of Finance, American Finance Association, vol. 59(3), pages 1235-1258, June.
  • Handle: RePEc:bla:jfinan:v:59:y:2004:i:3:p:1235-1258
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