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Options Arbitrage in Imperfect Markets

1989; Wiley; Volume: 44; Issue: 5 Linguagem: Inglês

10.2307/2328643

1540-6261

Stephen Figlewski,

Financial Markets and Investment Strategies

The Journal of FinanceVolume 44, Issue 5 p. 1289-1311 Article Options Arbitrage in Imperfect Markets STEPHEN FIGLEWSKI, STEPHEN FIGLEWSKI Stern School of Business, New York University. The author would like to thank John Merrick, Roni Michaely, William Silber, and the referee, Mark Rubinstein, for helpful comments.Search for more papers by this author STEPHEN FIGLEWSKI, STEPHEN FIGLEWSKI Stern School of Business, New York University. The author would like to thank John Merrick, Roni Michaely, William Silber, and the referee, Mark Rubinstein, for helpful comments.Search for more papers by this author First published: December 1989 https://doi.org/10.1111/j.1540-6261.1989.tb02654.xCitations: 160 Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL ABSTRACT Option valuation models are based on an arbitrage strategy—hedging the option against the underlying asset and rebalancing continuously until expiration—that is only possible in a frictionless market. This paper simulates the impact of market imperfections and other problems with the "standard" arbitrage trade, including uncertain volatility, transactions costs, indivisibilities, and rebalancing only at discrete intervals. We find that, in an actual market such as that for stock index options, the standard arbitrage is exposed to such large risk and transactions costs that it can only establish very wide bounds on equilibrium options prices. This has important implications for price determination in options markets, as well as for testing of valuation models. REFERENCES Beckers, S., 1981, Standard deviations implied in option prices as predictors of future stock price variability, Journal of Banking and Finance 5, 363– 382. Black, Fischer, 1976, Studies of stock price volatility changes, in Proceedings of the 1976 Meetings of the American Statistical Association, Business and Economics Statistics Section. Black, Fischer and Myron Scholes., 1972, The valuation of option contracts and a test of market efficiency, Journal of Finance 27, 399– 418. Boyle, Phelim, 1977, Options: A Monte Carlo approach, Journal of Financial Economics 4, 323– 338. Boyle, Phelim and David Emanuel., 1980, Discretely adjusted option hedges, Journal of Financial Economics 8, 259– 282. Brennan, Michael J., 1979, The pricing of contingent claims in discrete time models, Journal of Finance 34, 53– 68. Brennan, Michael J. and Eduardo Schwartz., 1988, Arbitrage in stock index futures, Working Paper, UCLA Graduate School of Management. Christie, Andrew, 1982, The stochastic behavior of common stock variances, Journal of Financial Economics 10, 407– 432. Etzioni, Eytan, 1986, Rebalance disciplines for portfolio insurance, Journal of Portfolio Management 13, 59– 62. Figlewski, Stephen, 1988, Arbitrage-based pricing of stock index options, Review of Research in Futures Markets 7, 250– 270. Galai, Dan, 1977, Tests of market efficiency of the Chicago Board Options Exchange, Journal of Business 50, 167– 197. Galai, Dan, 1983a, The components of the return from hedging options against stock, Journal of Business 56, 45– 54. Galai, Dan, 1983b, A survey of empirical tests of option pricing models, In M. Brenner, ed.: Option Pricing (D. C. Heath, Lexington, MA). Garcia, C. B. and F. J. Gould, 1987, An empirical study of portfolio insurance, Financial Analysts Journal 44– 54. Latane, Henry and Richard Rendleman., 1976, Standard deviations of stock price ratios implied in option prices, Journal of Finance 31, 369– 382. Leland, Hayne, 1985, Options pricing and replication with transactions costs, Journal of Finance 40, 1283– 1301. Macbeth, James and Larry Merville., 1979, An empirical examination of the Black-Scholes call option pricing model, Journal of Finance 34, 1173– 1186. Phillips, Susan and Clifford Smith., 1980, Trading costs for listed options: The implications for market efficiency, Journal of Financial Economics 8, 179– 201. Rubinstein, Mark, 1976, The valuation of uncertain income streams and the pricing of options, Bell Journal of Economics 7, 407– 425. Rubinstein, Mark, 1985, Nonparametric tests of alternative option pricing models using all reported trades and quotes on the 30 most active CBOE option classes from August 23, 1976 through August 31, 1978, Journal of Finance 40, 455– 480. Citing Literature Volume44, Issue5December 1989Pages 1289-1311 ReferencesRelatedInformation