The limitation of monotonicity property of option prices: an empirical evidence |
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| Authors: | Chuang Yuang Lin Dar Hsin Chen Chin Yu Tsai |
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| Institution: | 1. Department of Business Administration , National Taipei University , No. 69, Section 2, Chien-Kuo N. Road, Taipei 105, Taiwan cylin46@hotmail.com;3. Department of Business Administration , National Taipei University , No. 69, Section 2, Chien-Kuo N. Road, Taipei 105, Taiwan;4. Department of International Business , China University of Technology , Taipei, Taiwan |
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| Abstract: | Many option pricing models are based on the assumption that the underlying asset price follows one-dimensional diffusion process. An alternative approach is to test the properties that should hold for all models based on a given stochastic process for the underlying asset. Following Pérignon (2006 Pérignon, C. 2006. Testing the monotonicity property of option prices. Journal of Derivatives, 14: 61–76. Crossref] , Google Scholar]), we test the empirical validity of the monotonicity property for option prices by collecting all transaction data from 1 July 2006 to 31 December 2006 for option contracts traded on the Taiwan Futures Exchange (TAIFEX). We find that sampled intraday option prices violate the monotonicity property between 29.97% and 57% of the time, and that call and put prices often increase, or decrease, together. We also find evidence to show that the frequent violations of the monotonicity property are to a large extent attributable to microstructure effects and that they arise from rational trading tactics. |
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