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Hedging under the influence of transaction costs: An empirical investigation on FTSE 100 index options

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  • Andros Gregoriou
  • Jerome Healy
  • Christos Ioannidis

Abstract

The Black–Scholes (BS; F. Black & M. Scholes, 1973) option pricing model, and modern parametric option pricing models in general, assume that a single unique price for the underlying instrument exists, and that it is the mid‐ (the average of the ask and the bid) price. In this article the authors consider the Financial Times and London Stock Exchange (FTSE) 100 Index Options for the time period 1992–1997. They estimate the ask and bid prices for the index, and show that, when substituted for the mid‐price in the BS formula, they provide superior option price predictors, for call and put options, respectively. This result is reinforced further when they .t a non‐parametric neural network model to market prices of liquid options. The empirical .ndings in this article suggest that the ask and bid prices of the underlying asset provide a superior fit to the mid/closing price because they include market maker's, compensation for providing liquidity in the market for constituent stocks of the FTSE 100 index. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:471–494, 2007

Suggested Citation

  • Andros Gregoriou & Jerome Healy & Christos Ioannidis, 2007. "Hedging under the influence of transaction costs: An empirical investigation on FTSE 100 index options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 27(5), pages 471-494, May.
    • Handle: RePEc:wly:jfutmk:v:27:y:2007:i:5:p:471-494
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    Cited by:

    1. Barry A. Goss & S. Gulay Avsar, 2013. "Simultaneity, Forecasting and Profits in London Copper Futures," Australian Economic Papers, Wiley Blackwell, vol. 52(2), pages 79-96, June.
    2. Johannes Ruf & Weiguan Wang, 2019. "Neural networks for option pricing and hedging: a literature review," Papers 1911.05620, arXiv.org, revised May 2020.
    3. Fei Chen & Charles Sutcliffe, 2012. "Pricing And Hedging Short Sterling Options Using Neural Networks," Intelligent Systems in Accounting, Finance and Management, John Wiley & Sons, Ltd., vol. 19(2), pages 128-149, April.
    4. Jang, H. & Lee, J., 2019. "Machine learning versus econometric jump models in predictability and domain adaptability of index options," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 513(C), pages 74-86.

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