Margin Rules, Informed Trading in Derivatives and Price Dynamics
We analyze the impact of option trading and margin rules on the behavior of informed traders and on the microstructure of stock and option markets. In the absence of binding margin requirements, the introduction of an options market causes informed traders to exhibit a relative trading bias towards the stock because of its greater information sensitivity. In turn, this widens the stock's bid-ask spread. But when informed traders are subject to margin requirements, their bias towards the stock is enhanced or mitigated depending on the leverage provided by the option relative to the stock, leading to wider or narrower stock bid-ask spreads. The introduction of option trading, with or without margin requirements, unambiguously improves the informational efficiency of stock prices. Margin rules improve market efficiency when stock margins and options margins (relative to stock margins) are sufficiently large or small but not when they are of moderate size.
|Date of creation:|
|Date of revision:|
|Contact details of provider:|| Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126|
Phone: (212) 998-0100
Web page: http://w4.stern.nyu.edu/finance/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Back, Kerry, 1993. "Asymmetric Information and Options," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 435-72.
- Gikas A. Hardouvelis, 1988.
"Margin requirements, volatility, and the transitory component of stock prices,"
8818, Federal Reserve Bank of New York.
- Hardouvelis, Gikas A, 1990. "Margin Requirements, Volatility, and the Transitory Components of Stock Prices," American Economic Review, American Economic Association, vol. 80(4), pages 736-62, September.
- Gikas A. Hardouvelis, 1989. "Margin requirements, volatility and the transitory component of stock prices," Research Paper 8909, Federal Reserve Bank of New York.
- Hardouvelis, G.A., 1988. "Margin Requirements, Volatility, And The Transitory Component Of Stock Prices," Papers fb-_88-38, Columbia - Graduate School of Business.
- Fedenia, Mark & Grammatikos, Theoharry, 1992. "Options Trading and the Bid-Ask Spread of the Underlying Stocks," The Journal of Business, University of Chicago Press, vol. 65(3), pages 335-51, July.
- 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, 04.
- Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
- Chowdhry, Bhagwan & Nanda, Vikram, 1998. "Leverage and Market Stability: The Role of Margin Rules and Price Limits," The Journal of Business, University of Chicago Press, vol. 71(2), pages 179-210, April.
- Hsieh, David A & Miller, Merton H, 1990. " Margin Regulation and Stock Market Volatility," Journal of Finance, American Finance Association, vol. 45(1), pages 3-29, March.
- Grossman, Sanford J, 1988.
"An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies,"
The Journal of Business,
University of Chicago Press, vol. 61(3), pages 275-98, July.
- Sanford J. Grossman, 1987. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," NBER Working Papers 2357, National Bureau of Economic Research, Inc.
- Milgrom, Paul & Stokey, Nancy, 1982.
"Information, trade and common knowledge,"
Journal of Economic Theory,
Elsevier, vol. 26(1), pages 17-27, February.
- Seguin, Paul J., 1990. "Stock volatility and margin trading," Journal of Monetary Economics, Elsevier, vol. 26(1), pages 101-121, August.
- Skinner, Douglas J., 1989. "Options markets and stock return volatility," Journal of Financial Economics, Elsevier, vol. 23(1), pages 61-78, June.
- Biais, Bruno & Hillion, Pierre, 1994. "Insider and Liquidity Trading in Stock and Options Markets," Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 743-80.
When requesting a correction, please mention this item's handle: RePEc:fth:nystfi:99-047. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Thomas Krichel)
If references are entirely missing, you can add them using this form.