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Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets

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  • Eli Ofek
  • Matthew Richardson
  • Robert F. Whitelaw

Abstract

In this paper, we investigate empirically the well-known put-call parity no-arbitrage relation in the presence of short sale restrictions. We use a new and comprehensive sample of options on individual stocks in combination with a measure of the cost and difficulty of short selling, specifically the spread between the rate a short-seller earns on the proceeds from the sale relative to the standard rate (the rebate rate spread). We find that violations of put-call parity are asymmetric in the direction of short sales constraints, their magnitudes are strongly related to the rebate rate spread, and they are maintained even in the presence of transactions costs both in the options and equity lending market. These violations appear to be related to both the maturity of the option and the level of valuations in the stock market, consistent with a behavioral finance theory that relies on over-optimistic investors in the stock market and segmentation between the stock and options markets. Moreover, the extent of violations of put-call parity and the rebate rate spread for individual stocks are significant predictors of future stock returns. For example, cumulative abnormal returns, net of borrowing costs, over a 2«-year sample period can exceed 65%.

Suggested Citation

  • Eli Ofek & Matthew Richardson & Robert F. Whitelaw, 2003. "Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets," NBER Working Papers 9423, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:9423
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    References listed on IDEAS

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    Cited by:

    1. Marsh, Ian W. & Payne, Richard, 2012. "Banning short sales and market quality: The UK’s experience," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 1975-1986.
    2. Owen Lamont, 2004. "Go Down Fighting: Short Seller vs. Firms," Yale School of Management Working Papers amz2521, Yale School of Management, revised 01 Aug 2004.
    3. Flynn, Sean Masaki, 2003. "Limited Arbitrage, Segmentation, and Investor Heterogeneity: Why the Law of One Price So Often Fails," Vassar College Department of Economics Working Paper Series 56, Vassar College Department of Economics.
    4. David M. Schizer & Michael R. Powers & Martin Shubik, 2003. "Market Bubbles and Wasteful Avoidance: Tax and Regulatory Constraints on Short Sales," Yale School of Management Working Papers ysm356, Yale School of Management.
    5. Han, Bin, 2004. "Limits of Arbitrage, Sentiment and Pricing Kernal: Evidences from Index Options," Working Paper Series 2004-2, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    6. Flynn, Sean Masaki, 2004. "Arbitrage in Closed-end Funds: New Evidence," Vassar College Department of Economics Working Paper Series 57, Vassar College Department of Economics.

    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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