Options and Market Friction
28 Pages Posted: 5 Mar 2011
Date Written: March 4, 2011
Abstract
In this study we test whether the introduction of options decreases market friction using the Hou and Moskowitz (2006) measure of price delay. Consistent with theory in Ross (1976), we find that the availability of options increases the flow of market-wide information into stock prices. Indeed, we find that option trading activity drives the increase in the flow of information as post-listing option volume relates negatively with price delay. In additional tests, we find that delay’s return premium, documented in Hou and Moskowitz (2006), markedly decreases after options list and is further decreasing in the level of post-listing option volume. Our findings indirectly fail to find support for the argument that introducing speculation into markets, via options, destabilizes prices (Hart and Kreps, 1986; and Stein, 1987).
Keywords: Options, Friction, Price Delay
Suggested Citation: Suggested Citation
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