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Price Discovery in Stock and Option Markets: A Portfolio Approach

70 Pages Posted: 16 May 2009  

Jung Hwang

University of Houston - C.T. Bauer College of Business

Raul Susmel

University of Houston - Department of Finance

Date Written: May 14, 2009

Abstract

In this paper, we propose a new portfolio approach to estimate Hasbrouck's (1995) information share (IS), which measures the relative contribution of one market to the variance of an efficient stock return process. Using GMM, we are able to estimate optimal weights for a portfolio of options to be used in Hasbrouck's (1995) analysis. With our dataset, IS of the option market using only ATM call options lies between 31% and 46%, while IS using a portfolio of options lies between 47% and 58%, a statistically significant increase. This finding indicates that using only one type of options, as often done in the literature, may result in an underestimated measure. We also find that as we increase the resolution of the data from 30 seconds to 15 minutes, the weight of OTM options in a portfolio increases from 18% to 32%. This result shows that the OTM option market's information takes time to be incorporated into stock prices since the information travels across stock and option markets.

Keywords: Price discovery, Information share, efficient stock prices, GMM

JEL Classification: G14, C52

Suggested Citation

Hwang, Jung and Susmel, Raul, Price Discovery in Stock and Option Markets: A Portfolio Approach (May 14, 2009). Available at SSRN: https://ssrn.com/abstract=1404988 or http://dx.doi.org/10.2139/ssrn.1404988

Jung Hwang (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Raul Susmel

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4763 (Phone)
713-743-4789 (Fax)

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