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

46 Pages Posted: 3 Nov 2008

See all articles by Eli Ofeka

Eli Ofeka

affiliation not provided to SSRN

Matthew P. Richardson

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); AQR Capital Management, LLC

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

Date Written: 2002

Abstract

In this paper, we investigate empirically the well-known put-call parity no-arbitragerelation in the presence of short sale restrictions. We use a new and comprehensivesample of options on individual stocks in combination with a measure of the cost anddifficulty of short selling, specifically the spread between the rate a short-seller earns on the proceeds from the sale relative to the normal rate (the rebate rate spread). We findstatistically and economically significant violations of put-call parity that are strongly related to the rebate rate spread. Stocks with negative rebate rate spreads exhibit prices in the stock market that are up to 7.5% greater than those implied in the options market (for the extreme 1% tail). Even after accounting for transaction costs in the options markets, these violations persist and their magnitude appears to be related to the general level of valuations in the stock market. 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 2½-year sample period can exceed 70%. It is difficult to reconcile these results with rational models of investor behavior, and, in fact, they are consistent with the presence of overoptimistic irrational investors in the markets for some individual securities.

Suggested Citation

Ofeka, Eli and Richardson, Matthew P. and Whitelaw, Robert F., Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets (2002). NYU Working Paper No. FIN-02-034. Available at SSRN: https://ssrn.com/abstract=1294212

Eli Ofeka (Contact Author)

affiliation not provided to SSRN

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Matthew P. Richardson

New York University (NYU) - Department of Finance ( email )

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National Bureau of Economic Research (NBER)

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AQR Capital Management, LLC ( email )

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Robert F. Whitelaw

New York University ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0338 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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