An Option Theoretic Approach to Market Efficiency

Annals of Financial Economics

21 Pages Posted: 5 Jun 2018 Last revised: 29 Nov 2021

Date Written: December 19, 2019

Abstract

I use five separate measures of deviation from Put-Call Parity of options on a stock without splits or dividends as separate negative measures for market efficiency. I rely upon the theory of trading volume as a function of short sales costs, etc., and that of market efficiency as a function of trading volume, etc. derived by Bhattacharya (2019). I use Three-Stage Least Squares (3SLS) to estimate this structural system, separately for Nasdaq and non-Nasdaq U.S. stocks. I find, contrary to much previous theoretical and empirical work, that the impact of short sales costs & constraints on market efficiency is not significantly negative and that the impact of trading volume on market efficiency is not significantly positive, and my results are robust to various econometric specifications and financial economic assumptions.

Keywords: Market Efficiency; Short Sales Costs; Short Sales Constraints; Options; Put-Call Parity; Implied Volatility; Volume; Investor Dispersion; Transaction Costs; Market Makers; Market Capitalization; Analysts; Fama-French Factors; Institutional Ownership

JEL Classification: G14; G12; G13; C58; C33; C36

Suggested Citation

Bhattacharya, Rajeev, An Option Theoretic Approach to Market Efficiency (December 19, 2019). Annals of Financial Economics, Available at SSRN: https://ssrn.com/abstract=3178740 or http://dx.doi.org/10.2139/ssrn.3178740

Rajeev Bhattacharya (Contact Author)

Washington Finance and Economics ( email )

United States

HOME PAGE: http://washington-finance.com

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