The lead-lag relation between options and stocks has been a subject of controversy for years with conflicting findings in the literature. In this thesis, we present an intuitive method to examine the lead-lag relation, if any, in the tick-by-tick data of covered warrants and their underlying stocks or underlying index futures. Our method is non-parametric and needs no assumptions which are critical to the regression-based methods.
We find that the electronically traded warrants do not lead stocks or index futures; the movements in the warrants' quotes provide little information about the quotes of the underlying stocks or index futures. Instead, our analysis shows that the stocks and index futures lead the warrants. Moreover, if all transaction costs are ignored, we can use the movements of underlying assets' quotes to generate profits by trading warrants that are both statistically and economically significant. However, as soon as the bid-ask spread is accounted for, the profits disappear and sizable losses are incurred instead. These findings are consistent with a central tenet of financial economics: arbitraging two intimately related markets for a profit is not possible in the presence of market frictions.
|School:||Singapore Management University (Singapore)|
|Department:||Lee Kong Chian School of Business|
|School Location:||Republic of Singapore|
|Source:||MAI 49/03M, Masters Abstracts International|
|Keywords:||Electronically traded warrants, Equity option market, Portfolio and security analysis, Pricing theories, Stock price behaviors, Underlying security|
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