Noise Traders, Mispricing, and Price Adjustments in Derivatives Markets
32 Pages Posted: 30 Jan 2019
Date Written: January 22, 2019
This study examines price disagreements and adjustments between actual futures prices and options-implied futures prices in an elaborate setting. We identify which market triggers each type of price disagreement and find that the market that initiates the disagreement adjusts more to eliminate the mispricing. Futures prices adjust less for options-initiated price disagreement events with out-of-the-money (OTM) options-implied prices than they do for events with at-the-money (ATM) prices. Options markets adjust more for disagreements initiated by OTM options than they do for disagreements initiated by ATM options. Adjustments in both the futures and options markets consistently suggest the information inferiority of OTM options trading. We also find that price disagreements are positively correlated with the participation of domestic investors, especially for OTM options-initiated disagreement events, implying that domestic traders are noisier and more uninformed than foreign investors are.
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