Price Discovery Across Equity and Option Markets
University of Arizona - Eller College of Management
September 13, 2013
This paper measures the channels by which private information is incorporated in prices in the equity and option markets. Using a mispricing events approach and conditioning on the option market being the cause of the mispricing event, I analyse the subsequent behaviour of both the options and equity markets. I find that options markets play an important role in the price discovery process. When conditioning on mispricing events caused by the option market, the equity price adjusts towards the options price to reconcile the prices. When the equity market causes the mispricing, the option market follows due to the autoquote mechanism that is used. Additionally, I use Monte Carlo to assess the suitability of the Hasbrouck (1995) information share measure to identify the price discovery roles each of the equity and options markets play, and find that research design choices that are not sensitive to actual market structures can distort the importance this measure assigns option market.
Keywords: Options, Price Discovery, Market Microstructure
JEL Classification: G14working papers series
Date posted: September 15, 2013 ; Last revised: November 27, 2013
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