Trading Costs and the Relative Rates of Price Discovery in Stock, Futures, and Option Markets

Posted: 24 Oct 1999

See all articles by Jeff Fleming

Jeff Fleming

Rice University - Jesse H. Jones Graduate School of Business

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business

Robert E. Whaley

Vanderbilt University - Finance

Abstract

In frictionless and rational markets, perfect substitutes must have the same price. In markets with trading costs, however, price differences may be as large as the costs of executing the arbitrage between markets. Moreover, if trading costs differ, trading activity will tend to be concentrated in the lowest-cost market. This study tests the differential trading cost hypothesis by examining the rate at which new information is incorporated in stock, index futures, and index option prices. The lead/lag return relations among markets are consistent with their relative trading costs. Prices in the index derivative markets appear to lead prices in the stock market. At the same time, index futures prices tend to lead index option prices, and the prices of index calls and index puts move together. The trading cost hypothesis reconciles the disparity found between the temporal relation in the stock index/index derivative markets versus the stock/stock option markets.

JEL Classification: G11, G12, G13, G14

Suggested Citation

Fleming, Jeff and Ostdiek, Barbara and Whaley, Robert E., Trading Costs and the Relative Rates of Price Discovery in Stock, Futures, and Option Markets. Available at SSRN: https://ssrn.com/abstract=6168

Jeff Fleming (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-4677 (Phone)
713-348-5251 (Fax)

HOME PAGE: http://www.ruf.rice.edu/~jfleming

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-5384 (Phone)
713-348-5251 (Fax)

Robert E. Whaley

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-343-7747 (Phone)
615-376-8879 (Fax)

Register to save articles to
your library

Register

Paper statistics

Abstract Views
2,349
PlumX Metrics