Information Asymmetry, Bid-Ask Spreads and Option Returns

28 Pages Posted: 23 Jul 2003

See all articles by Fredrik Berchtold

Fredrik Berchtold

Stockholm University - Department of Corporate Finance

Lars L. Norden

Stockholm University - Stockholm Business School

Abstract

This study analyses the information asymmetry at the stock market considering two different types of information flow. The first type represents changes in information where informed traders know if the stock price will increase or decrease. The second type is less specific - the direction is unknown, but informed traders know that the stock price either will increase or decrease. The different flows of information are estimated within a GARCH framework, using shocks in Swedish OMX-index returns and index option strangle returns respectively. The results show significant conditional variance in index returns and options strangle returns, although with notable differences. The index returns exhibit a high level of variance persistence, and an asymmetric initial impact of return shocks to variance (leverage effect). The strangle returns have a relatively low variance persistence, but a higher (and more symmetric) initial impact of return shocks. A time series regression of call and put option bid-ask spreads is performed, relating spreads to these two types of information, as well as other explanatory variables. The results show that option spreads are related to shocks in index and options strangle returns, as well as the conditional variance of the stock returns. Hence, market makers appear to alter option bid-ask spreads primarily in response to unexpected shocks in stock and strangle returns - and to changes in the expected variance level of stock returns.

Keywords: information asymmetry, option bid-ask spreads, time series analysis, stock and strangle return shocks

JEL Classification: G10, G13, G14

Suggested Citation

Berchtold, Fredrik and Nordén, Lars L., Information Asymmetry, Bid-Ask Spreads and Option Returns. EFA 2003 Annual Conference Paper No. 147. Available at SSRN: https://ssrn.com/abstract=424520 or http://dx.doi.org/10.2139/ssrn.424520

Fredrik Berchtold

Stockholm University - Department of Corporate Finance ( email )

Universitetsvägen 10
Stockholm, Stockholm SE-106 91
Sweden

Lars L. Nordén (Contact Author)

Stockholm University - Stockholm Business School ( email )

Sweden

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