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Modeling stock pinning

  • Jeannin, M.
  • Iori, G.
  • Samuel, D.

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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Paper provided by Department of Economics, City University London in its series Working Papers with number 06/04.

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Date of creation: 2006
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Handle: RePEc:cty:dpaper:06/04
Contact details of provider: Postal: Department of Economics, Social Sciences Building, City University London, Whiskin Street, London, EC1R 0JD, United Kingdom,
Phone: +44 (0)20 7040 8500
Web page: http://www.city.ac.uk

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  1. Giulia Iori & Carl Chiarella, 2002. "A simple microstructure model of double auction markets," Computing in Economics and Finance 2002 44, Society for Computational Economics.
  2. Challet, Damien & Stinchcombe, Robin, 2001. "Analyzing and modeling 1+1d markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 300(1), pages 285-299.
  3. 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.
  4. 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.
  5. Eckhard Platen & Martin Schweizer, 1998. "On Feedback Effects from Hedging Derivatives," Mathematical Finance, Wiley Blackwell, vol. 8(1), pages 67-84.
  6. Kempf, Alexander & Korn, Olaf, 1999. "Market depth and order size1," Journal of Financial Markets, Elsevier, vol. 2(1), pages 29-48, February.
  7. 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.
  8. Marco Avellaneda & Michael Lipkin, 2003. "A market-induced mechanism for stock pinning," Quantitative Finance, Taylor & Francis Journals, vol. 3(6), pages 417-425.
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