Alternative Market Structures for Derivatives
In this paper, we compare option contracts from a traditional derivatives exchange to bank-issued options, also referred to as covered warrants, whose markets have grown rapidly around the world in recent years. While bank-issued option markets and traditional derivatives exchanges exhibit significant structural differences such as the absence of a central counterparty for bank-issued options, they frequently exist side-by-side, and the empirical evidence shows that there is significant overlap in their product offerings. We examine trading costs and liquidity in both markets and find that bank-issued options have smaller quoted percentage bid-ask spreads than traditional option contracts by an average of 4.3%. The bid-ask spread difference manifests itself in a highly regular fashion in that ask (bid) prices for bank-issued options are consistently higher than comparable ask (bid) prices for traditional option contracts. The difference of the bid prices is larger than the difference of the ask prices resulting in smaller bid-ask spreads for bank-issued options. The empirical analysis also indicates that bid-ask spreads in either market are lowered by competition from the other market. We present a potential explanation for the co-existence of the two market structures which suggests that the bank-issued option market caters more towards retail investors with predominantly speculative motives while traditional derivatives exchanges may cater more towards institutional investors with predominantly hedging motives.
|Date of creation:||13 Nov 2003|
|Date of revision:||12 Dec 2003|
|Note:||Type of Document - PDF; prepared on IBM PC; pages: 47|
|Contact details of provider:|| Web page: http://econwpa.repec.org|
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.:
- Young-Hye Cho & Robert F. Engle, 1999.
"Modeling the Impacts of Market Activity on Bid-Ask Spreads in the Option Market,"
NBER Working Papers
7331, National Bureau of Economic Research, Inc.
- Engle, Robert F, 1999. "Modeling the Impacts of Market Activity on Bid-Ask Spreads in the Option Market," University of California at San Diego, Economics Working Paper Series qt6rp7g17q, Department of Economics, UC San Diego.
- Günter Franke & Martin Weber, 2001.
"Heterogeneity of Investors and Asset Pricing in a Risk-Value World,"
CoFE Discussion Paper
01-08, Center of Finance and Econometrics, University of Konstanz.
- Franke, Günter & Weber, Martin, 2003. "Heterogeneity of Investors and Asset Pricing in a Risk-Value World," CEPR Discussion Papers 3832, C.E.P.R. Discussion Papers.
- Chan, Howard Wei-Hong & Pinder, Sean M., 2000. "The value of liquidity: Evidence from the derivatives market," Pacific-Basin Finance Journal, Elsevier, vol. 8(3-4), pages 483-503, July.
- Ter Horst, J.R. & Veld, C.H., 2002. "Behavioral Preferences for Individual Securities : The Case for Call Warrants and Call Options," Discussion Paper 2002-95, Tilburg University, Center for Economic Research.
- Dietmar P.J. Leisen and Kenneth L. Judd, 2001. "A Partial Equilibrium Model of Option Markets," Computing in Economics and Finance 2001 219, Society for Computational Economics.
- Barone-Adesi, Giovanni & Whaley, Robert E, 1987. " Efficient Analytic Approximation of American Option Values," Journal of Finance, American Finance Association, vol. 42(2), pages 301-20, June.
- Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September.
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpfi:0311007. 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: (EconWPA)
If references are entirely missing, you can add them using this form.