The Informational Value of Consensus Prices: Evidence from the OTC Derivatives Market

45 Pages Posted: 5 Jun 2018

See all articles by Lerby Murat Ergun

Lerby Murat Ergun

London School of Economics & Political Science (LSE); Bank of Canada

Andreas Uthemann

London School of Economics & Political Science (LSE)

Date Written: May 23, 2018

Abstract

This paper provides empirical evidence on the ability of consensus prices to reduce valuation uncertainty in the over-the-counter market for financial derivatives. The analysis is based on a proprietary data set of price estimates for S&P500 index options provided by major broker-dealers to a consensus pricing service. We develop and estimate a model of learning about fundamental asset values from consensus prices. The panel dimension of the data set allows us to estimate Bayesian updating dynamics at the individual broker-dealer level. We find that uncertainty about index option values, as measured by the variance of broker-dealers' posterior beliefs about the options' fundamental value, is substantial across the volatility surface of S&P500 index options that are traded over-the-counter. The 95% confidence intervals around posterior means can be as large as 10 volatility points for index options with strike prices that correspond to extreme moves of the S&P500 index. Having access to consensus pricing data is found to significantly reduce broker-dealers' strategic uncertainty, that is uncertainty about the positioning of their option valuations in relation to other market participants' valuations.

Keywords: OTC markets, information aggregation, learning, consensus pricing

JEL Classification: C58, D53, D83, G12, G14

Suggested Citation

Ergun, Lerby Murat and Uthemann, Andreas, The Informational Value of Consensus Prices: Evidence from the OTC Derivatives Market (May 23, 2018). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=3190642 or http://dx.doi.org/10.2139/ssrn.3190642

Lerby Murat Ergun (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Andreas Uthemann

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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