Modeling stock pinning
This paper investigates the effect of hedging strategies on the so-called pinning effect, i.e. the tendency of stock's prices to close near the strike price of heavily traded options as the expiration date nears. In the paper we extend the analysis of Avellaneda and Lipkin, who propose an explanation of stock pinning in terms of delta hedging strategies for long option positions. We adopt a model introduced by Frey and Stremme and show that, under the original assumptions of the model, pinning is driven by two effects: a hedging-dependent drift term that pushes the stock price toward the strike price and a hedging-dependent volatility term that constrains the stock price near the strike as it approaches it. Finally, we show that pinning can be generated by simulating trading in a double auction market. Pinning in the microstructure model is consistent with the Frey and Stremme model when both discrete hedging and stochastic impact are taken into account.
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|Date of creation:||2006|
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- Jean-Philippe Bouchaud & Marc Mezard & Marc Potters, 2002. "Statistical properties of stock order books: empirical results and models," Quantitative Finance, Taylor & Francis Journals, vol. 2(4), pages 251-256.
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- Xiaoyan Ni, Sophie & Pearson, Neil D. & Poteshman, Allen M., 2005. "Stock price clustering on option expiration dates," Journal of Financial Economics, Elsevier, vol. 78(1), pages 49-87, October.
- Jean-Philippe Bouchaud & Marc Mezard & Marc Potters, 2002. "Statistical properties of stock order books: empirical results and models," Science & Finance (CFM) working paper archive 0203511, Science & Finance, Capital Fund Management.
- Giulia Iori & Carl Chiarella, 2002. "A simple microstructure model of double auction markets," Computing in Economics and Finance 2002 44, Society for Computational Economics.
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