Put-Call Parity Violations and Return Predictability: Evidence from the 2008 Short Sale Ban
57 Pages Posted: 12 Jul 2011 Last revised: 24 Sep 2020
Date Written: April 12, 2019
Abstract
We investigate the link between stock and options markets during the 2008 U.S. short sale ban. First, we find definitive evidence that the ban indeed caused stock overvaluation.Second, we show that the short sale ban caused a significant increase in put-call parity violations only in the direction of the short sale constraints and it significantly enhanced the stock return predictability of put-call parity violations. Third, the documented over-valuation is really large. A portfolio formed on the trading signal that the put-call parity violation is in the top quintile underperforms the lowest quintile portfolio by a statistically and economically significant abnormal daily return of 5.6% during the short sale ban period. We employ a novel and rigorous method of using TAQ intraday data to ensure that our high-low violation arbitrage portfolio as well as the five Fama-French factors used to
estimate the abnormal returns are actually investible.
Keywords: Short sale ban; put-call parity; return predictability; limits to arbitrage; market efficiency; information flow
JEL Classification: G13, G14
Suggested Citation: Suggested Citation
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