Specialist: The firm or the individual?: Empirical evidence from the options markets

This paper investigates the role of the individual specialist vis-à-vis that of the specialist firm on the quality of markets. While previous studies have not denied the importance of the individual, they have focused exclusively on the performance of the specialist firm. This study is the first empirical test of the specialist as an individual and his influence on market quality. By implication, it tests whether the firm is the appropriate level of analysis. Within specialist firms, we find significant differences in quoting behavior while the evidence on execution quality is mixed. Some firms are able to design an effective mechanism that enforces uniformity in goals of the members of the firm. Considering that exchanges are unable to impose such uniform performance, these firms appear to have better incentive or penalty systems in place. However, the existence of other firms where significant differences in execution quality exist, presents a challenge to policy makers, as differences in execution quality within a firm indicate that the disclosure of market quality needs to be at the post-level, not just at the firm level.     

Duration analysis of venture capital staging: A real options perspective

This study takes a real options perspective towards venture capital staging and views the staging decision as a choice between holding the current option to invest and investing now to obtain the option to invest subsequently. It proposes that this staging decision depends on the factors that influence the value of these two options, such as competition and various sources of uncertainty. The empirical results suggest that market uncertainty encourages venture capital firms to delay investing at each round of financing, whereas competition, project-specific uncertainty and agency concerns prompt venture capital firms to invest sooner. This study has useful implications for theory and practice.     

A random walk down the options market

Under the efficient market hypothesis, option‐implied forward variance forms a martingale and changes in forward variance follow a random walk. In this study, we extract forward variance from option prices following a model‐free approach and empirically test the random walk hypothesis. Although results from standard orthogonality tests support the martingale restriction, further results from autoregressive regressions seem to reject the martingale restriction as daily changes in forward variance are found to exhibit negative autocorrelation. However, this anomalous pattern of negative correlation is fully explained by illiquidity effects. Overall, the findings support the random walk hypothesis and informational efficiency of the options market. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark 32:505–535, 2012     

Distributions implied by American currency futures options: A ghost's smile?

A new and easily applicable method for estimating risk‐neutral distributions (RND) implied by American futures options is proposed. It amounts to inverting the Barone‐Adesi and Whaley method (BAW method) to get the BAW implied volatility smile. Extensive empirical tests show that the BAW smile is equivalent to the volatility smile implied by corresponding European options. Therefore, the procedure leads to a legitimate RND estimation method. Further, the investigation of the currency options traded on the Chicago Mercantile Exchange and OTC markets in parallel provides us with insights on the structure and interaction of the two markets. Unequally distributed liquidity in the OTC market seems to lead to price distortions and an ensuing interesting “ghost‐like” shape of the RND density implied by CME options. Finally, using the empirical results, we propose a parsimonious generalization of the existing methods for estimating volatility smiles from OTC options. A single free parameter significantly improves the fit. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:147–178, 2004     

Pricing American options with stochastic volatility: Evidence from S&P 500 futures options

This article is the first attempt to test empirically a numerical solution to price American options under stochastic volatility. The model allows for a mean‐reverting stochastic‐volatility process with non‐zero risk premium for the volatility risk and correlation with the underlying process. A general solution of risk‐neutral probabilities and price movements is derived, which avoids the common negative‐probability problem in numerical‐option pricing with stochastic volatility. The empirical test shows clear evidence supporting the occurrence of stochastic volatility. The stochastic‐volatility model outperforms the constant‐volatility model by producing smaller bias and better goodness of fit in both the in‐sample and out‐of‐sample test. It not only eliminates systematic moneyness bias produced by the constant‐volatility model, but also has better prediction power. In addition, both models perform well in the dynamic intraday hedging test. However, the constant‐volatility model seems to have a slightly better hedging effectiveness. The profitability test shows that the stochastic volatility is able to capture statistically significant profits while the constant volatility model produces losses. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:625–659, 2000     

Pricing options using implied trees: Evidence from FTSE‐100 options

Previously, few, if any, comparative tests of performance of Jackwerth's ( 1997 ) generalized binomial tree (GBT) and Derman and Kani ( 1994 ) implied volatility tree (IVT) models were done. In this paper, we propose five different weight functions in GBT and test them empirically compared to both the Black‐Scholes model and IVT. We use the daily settlement prices of FTSE‐100 index options from January to November 1999. With both American and European options traded on the FTSE‐100 index, we construct both GBT and IVT from European options and examine their performance in both the hedging of European option and the pricing of its American counterpart. IVT is found to produce least hedging errors and best results for American call options with earlier maturity than the maturity span of the implied trees. GBT appears to produce better results for American ATM put pricing for any maturity, and better in‐sample fit for options with maturity equal to the maturity span of the implied trees. Deltas calculated from IVT are consistently lower (higher) than Black‐Scholes deltas for both European and American calls (puts) in absolute term. The reverse holds true for GBT deltas. These empirical findings about the relative performance of GBT, IVT, and Standard Black‐Scholes models are important to practitioners as they indicate that different methods should be used for different applications, and some cautions should be exercised. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:601–626, 2002     

Informed options trading on the implied volatility surface: A cross-sectional approach

This study investigates the cross-sectional implication of informed options trading across different strikes and maturities. We explore the term structure perspective of the one-way information transmission from options markets to stock markets by adopting well-known option-implied volatility measures to examine stock return predictability. Using equity options data for U.S. listed stocks spanning 2000–2013, we find that the shape of the long-term implied volatility curve exhibits extra predictive power for stock returns of subsequent months even after orthogonalizing the short-term components. Our findings indicate that the inter-market information asymmetry rapidly disappears before the expiration of long-term option contracts.     

A note on the valuation of compound options

The value of a compound option, an option on an option, has been derived by Geske (1976) using Fourier integrals. This article presents two alternative proofs to derive the value of a compound option. One proof is based on the martingale approach, which provides a simple and powerful tool for valuing contingent claims. The second proof uses the expectation of a truncated bivariate normal variable. These proofs allow for an intuitive interpretation of the three elements constituting the value of a compound option. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:1103–1115, 2002     

Pricing arithmetic Asian and Amerasian options: A diffusion operator integral expansion approach

In this paper, we propose a new explicit series expansion formula for the price of an arithmetic Asian option under the Black–Scholes model and Merton's jump-diffusion model. The method is based on an equivalence in law relation together with the diffusion operator integral method proposed by Heath and Platen. The method yields explicit series expansion formula for the Asian options' prices. The theoretical convergence of the expansion to the true value is established. We also consider the American Asian option (i.e., Amerasian option) and derive the corresponding expansion formula through the early exercise premium representation. Numerical results illustrate the accuracy and efficiency of the method as compared with benchmarks in the literature.     

Early exercise of American put options: Investor rationality on the Swedish equity options market

Using Swedish equity option data, this study investigates how well the actual exercise behavior of American put options corresponds to the early exercise rules. The optimal exercise strategy is established in two ways. First, the critical exercise price, above which a put option should be exercised early, is computed and compared to the actual exercise price. Second, the exercise value of the option is compared to its market bid price. The results show that most early exercise decisions conform to rational exercise behavior, even though a large number of failures to exercise are found. Most of the faulty exercises can also be discarded after a sensitivity analysis, although several failures to exercise are considered irrational, even after taking transaction costs into account. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:167–188, 2000