Bid-Ask Spread and Arbitrage Profitability: A Study of the Hong Kong Index Futures and Options Market
Posted: 12 Dec 1996
Date Written: Undated
This study utilizes both real-time transaction prices and bid-ask quotes in evaluating the profitability of arbitrage strategies for the Hong Kong index futures and index options market. Taking into account the bid-ask spread in identifying arbitrage opportunities, we avoid the selection bias problem associated with using transaction prices. The percentage of observations violating no-arbitrage bounds is significantly reduced when we employ bid-ask quotes instead of transaction prices. This suggests that studies which implement arbitrage strategies based on transaction prices employ prices from the wrong side of the spread. We find a relationship between the frequency of violations (evaluated from transaction prices) and the size of bid-ask spreads in the futures and options markets. This indicates that a larger mispricing, which may arise when the bid-ask spread is wider, does not necessarily imply profitable arbitrage opportunity.
JEL Classification: G13, G14
Suggested Citation: Suggested Citation