Mean Reversion Tests of Put-Call Parity for Equity Index Options with Randomization and Bayesian Gibbs Sampling Viewpoint: S&P500 Versus DAX

39 Pages Posted: 6 Feb 2004

See all articles by Anthony Tu

Anthony Tu

National Chengchi University

Doris Chin

National Chengchi University

Date Written: January 2004

Abstract

The put-call parity (PCP) is traditionally tested by examining whether arbitrage strategies earn ex post profits. These 'direct' tests of PCP caution that these violations of PCP suggest the arbitrage models are subject to significant risk due to market frictions. The previous empirical results also indicate that when market frictions are taken into account, the deviations form PCP can fluctuate within a bounded interval without giving rise to any arbitrage profit. In contrast with previous studies, we presents a model of the option price mean reverting to a function form of PCP. We employ variance ratio test to the deviations of PCP with randomization and Bayesian Gibbs sampling viewpoint in the context of a three-state Markov-switching model. The result shows that the PCP deviations from the electronic screen-traded DAX index option, which is calculated as if the dividends are reinvested in the index, displays mean reversion at long horizons. On the other hand, those deviations from the floor-traded S&P500 index option, which is not corrected for dividend payments, vary randomly.

Keywords: Variance Ratio Test, Bayesian Gibbs Sampling, Put-Call Parity, Markov-Switching Process, Mean Reversion

JEL Classification: G13, G15

Suggested Citation

Tu, Anthony and Chin, Doris, Mean Reversion Tests of Put-Call Parity for Equity Index Options with Randomization and Bayesian Gibbs Sampling Viewpoint: S&P500 Versus DAX (January 2004). Available at SSRN: https://ssrn.com/abstract=499604 or http://dx.doi.org/10.2139/ssrn.499604

Anthony Tu

National Chengchi University ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei 11623
Taiwan

Doris Chin

National Chengchi University

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei 11623
Taiwan