information spillovers between stock and options markets

Download Information spillovers between stock and options markets

Post on 01-Nov-2014

540 views

Category:

Business

0 download

Embed Size (px)

DESCRIPTION

 

TRANSCRIPT

  • 1. Information spillover effects between stock and option markets Fredrik Berchtold and Lars Nordn1 School of Business, Stockholm University, S-106 91 Stockholm, Sweden. Abstract This study analyses information spillover effects between the Swedish OMX stock index and the index option market. Two types of information are analysed in a bivariate Vectorized Autoregressive (VAR) setup with Generalized Autoregressive Conditional Heteroskedasticity (GARCH) errors. The first type represents information where an informed investor knows whether the stock index will increase or decrease. The second type is less specific, the direction is unknown, but an informed investor knows that the stock index either will increase or decrease. Possible information spillover effects are examined within a bivariate VAR- BEKK GARCH setting, with shocks to the Swedish OMX stock index and a delta neutral OMX options strangle portfolio as approximations of directional and undirectional information. Significant conditional variance spillover effects are detected. Mainly, todays options strangle shock have an effect on tomorrows conditional index returns variance; whereas stock index shocks not appears to distress the conditional option strangle variance. This is consistent with undirectional information preceding directional information or information spillover from the option market to the stock market. Keywords: Information asymmetry, Spillover, Multivariate, VAR, GARCH JEL classification: G10; G13; G14 1 Please send correspondence to Lars Nordn, e-mail: ln@fek.su.se
  • 2. Information spillover effects between stock and option markets Abstract This study analyses information spillover effects between the Swedish OMX stock index and the index option market. Two types of information are analysed in a bivariate Vectorized Autoregressive (VAR) setup with Generalized Autoregressive Conditional Heteroskedasticity (GARCH) errors. The first type represents information where an informed investor knows whether the stock index will increase or decrease. The second type is less specific, the direction is unknown, but an informed investor knows that the stock index either will increase or decrease. Possible information spillover effects are examined within a bivariate VAR- BEKK GARCH setting, with shocks to the Swedish OMX stock index and a delta neutral OMX options strangle portfolio as approximations of directional and undirectional information. Significant conditional variance spillover effects are detected. Mainly, todays options strangle shock have an effect on tomorrows conditional index returns variance; whereas stock index shocks not appears to distress the conditional option strangle variance. This is consistent with undirectional information preceding directional information or information spillover from the option market to the stock market. Keywords: Information asymmetry, Spillover, Multivariate, VAR, GARCH JEL classification: G10; G13; G14 2
  • 3. 1. Introduction In a review article, Madhavan (2000) suggests that asymmetric information models by Copeland and Galai (1993), Glosten and Milgrom (1985), Kyle (1983), Easley and OHara (1987), Black (1993), Foster and Viswanathan (1994) have a central role in the market microstructure literature. In these models it is assumed that market makers, obliged to simultaneously quote buy and sell prices of financial assets, yielding the bid-ask spread, have an information disadvantage compared to informed investors. To protect themselves market makers have to quote bid-ask spreads large enough to compensate for losses arising from trading with these informed investors. The result is higher transaction costs for less informed investors. With the stock market in mind, two different types of information can be identified, which implies two cases of informed investors. In one case informed investors know the direction of the price of certain stocks, which uninformed investors do not know. In the other case, informed investors only know that the stock prices will change, but not whether the prices will increase or decrease. The first information type can be called directional information and the second undirectional information. The first type of informed investors is likely to trade in the stock market, whereas the second type, having undirectional information, is likely to trade in the options market. In empirical studies Cherian and Jarrow (1998) and Nandi (1999) distinguish between these two types of information. The purpose of this study is to investigate the relationship between these two types of information. In doing so, stock index and options strangle returns are modelled as a bivariate Vectorized Autoregressive (VAR) process, where the variance- covariance matrix follows a bivariate GARCH(1,1) process2 estimated with the BEKK representation suggested by Engle and Kroner (1993).3 This setup enables an investigation of lead-lag relationships, or information spillover effects, in the return and variance-covariance equations. 2 GARCH is short for Generalised Autoregressive Conditional Heteroskedasticity. See e.g. Engle (1982) and Bollerslev (1986). 3 In an early version of the paper Yoshi Baba and Dennis Kraft contributed, which led to the acronym (BEKK). 3
  • 4. This study contributes to previous research in several ways. First, the causal conjunction of information asymmetry has not been empirically quantified in a similar manner before. The BEKK model provides a framework for investigating whether directional and undirectional information are independent or if one type of information precedes the other. Intuitively, it is reasonable to assume that undirectional information leads directional information, as it is more general. Secondly, both types of information are defined as stock index and options strangle shocks. Thereby, it is possible to test informational lead-lag relationships between the stock and options market, taking into account spillover effects in the first moment (mean equations) and the second moment (variance-covariance equations). The lead-lag relationship between stock and related futures markets has been extensively researched, for example by Stoll and Whaley (1990), Chan et al. (1991) and Chan (1992), but few have studied the stock index and index options markets.4 As a final contribution, Swedish index options data are analysed. This is the first time anyone has used data from the Swedish stock and options markets in this setting. The bivariate VAR(1) full BEKK GARCH(1,1) model is adequate for stock index and options strangle returns. In the VAR equations, no significant autocorrelations are detected, indicating no information spillover effects between stock index and options strangle returns or vice versa. More importantly, significant information spillover effects between the Swedish stock market and options market is detected in the variance-covariance equations. Somewhat simplified, lagged squared stock index and options strangle shocks do affect the conditional stock index variance, whereas the conditional options strangle variance only is affected by lagged squared options strangle shocks. Likewise, the conditional covariance is significantly affected by lagged squared strangle shocks, but not by lagged squared stock index shocks. In all three conditional variance/covariance equations past vales of the conditional variance/covariance also matters. These results are consistent with the idea that undirectional information precedes directional information, or that information spills over from the option market to the stock market. 4 Ng and Pirron (1996), Koutmos and Tucker (1996) as well as Kavussanos and Nomikos (2000) explicitly study second moment spillovers between the cash and futures markets. In addition to testing first moment spillovers, Cheung and Ng (1996) realize that volatility reflects information, and that second moment (volatility) spillovers are important as well. Also, Ross (1989) argues that volatility is related to the information flow. 4
  • 5. The remainder of the study is organised as follows. Section 2 contains a description of the Swedish market for OMX-stock index options. Section 3 presents the data and the methodology of the study, whereas section 4 contains the results of the empirical analysis. The study is ended in section 5 with some concluding remarks. 2. The Swedish market for OMX index options and futures In September 1986 the Swedish exchange for options and other derivatives (OM) introduced the OMX index, a value weighted stock index based on the 30 most actively traded stocks at the Stockholm Stock Exchange (StSE). The purpose was to use the index as an underlying security for trading standardised European options and futures. Since the introduction, the trading volume has grown substantially. Presently, it is ranked among the ten largest stock index options markets worldwide.5 All derivatives at OM are traded with a fully computerised system. The trading system consists of an electronic limit order book hosted by OM. During trading hours investors submit market or limit orders to either buy or sell a certain quantity of derivati

Recommended

View more >