Tick Size Reduction and Price Discovery in Option Markets: An Empirical Investigation
38 Pages Posted: 28 Feb 2011
Date Written: February 28, 2011
We examine the impact of the tick size reduction introduced by the CBOE in 2007 in its second pilot program on the simultaneous price discovery process in the markets for options and their underlying securities. We first document a major dependence in both the Information Shares (IS) and Component Shares (CS) approaches to the estimation of the price discovery metrics on the inversion method of the option value to find the implied stock price. We then introduce a more accurate inversion method that results in a major increase in the information shares of option markets for both IS and CS metrics compared to the dominant Lagged Implied Volatility (LIV) inversion method. In all cases, however, we document a major impact of the tick size reduction in the option market that increases the option market information shares for all metrics and all inversion methods.
Keywords: contingent claim, market microstructure, price discovery
JEL Classification: G14, G15
Suggested Citation: Suggested Citation