The Effect of Short Sale Constraint Removal on Volatility in the
Presence of Heterogeneous Beliefs
20 Pages Posted: 10 Aug 2007
We evaluate the effect of index option initiation on a stock market in which short sales are prohibited. Our focus is the effect on the price volatility of the underlying asset. In a very simple dynamic model with successive generations of single-period investors, we show that volatility can either increase or decrease, depending on the variability of news about final payoffs. As an empirical illustration, we consider data from the Israeli stock market. The data show that volatility increased following the initiation of index options, consistent with the fact that short sales were prohibited in Israel when index options were introduced.
Notes: Previously titled Heterogeneous Beliefs, Short Sale Constraint, And The Effect Of Index Option Initiation On Price, Utility And Volatility
Keywords: Options, Short Sales Constraint, Volatility
JEL Classification: G11, G12
Suggested Citation: Suggested Citation