Tie Su

IMPLIED VOLATILITY SKEWS AND STOCK INDEX SKEWNESS AND KURTOSIS IMPLIED BY S&P 500 INDEX OPTION PRICES

The Black-Scholes (1973) option pricing model is used to value a wide range of option contracts. However, the model often inconsistently prices deep in-themoney and deep out-of-the-money options. Options’ professionals refer to this phenomenon as a volatility ‘skew’ or ‘smile.’ In this paper, we apply an extension of the Black-Scholes model developed by Jarrow and Rudd (1982) to an investigation of S&P 500 index option prices. We find that non-normal skewness and kurtosis in option-implied distributions of index returns contribute significantly to the phenomenon of volatility skews.

How the Equity Market Responds to Unanticipated Events

We examine the market reaction of prices, volume, spreads, and trading location when firms experience events that are totally unanticipated by the equity market in terms of both timing and content. We find that the response time is longer than previous studies have reported. Selling pressure, wider spreads, and higher volume remain significant for over an hour. We also find an immediate price reaction for overnight events; however, the market takes longer to react to events that occur when it is open. These findings may shed light on the efficacy of trading halts.

A Simple Cost Reduction Strategy for Small Liquidity Traders: Trade at the Opening

We extend the market microstructure literature by examining trading strategies of a small discretionary liquidity trader in call and continuous markets. Our investigation of trading strategies uses intraday market and limit orders, and introduces the market-at-open order as an alternative strategy for a small liquidity trader. We find that a small trader can reduce transaction costs by trading at the opening. Using tick-by-tick transaction data, we demonstrate that the market-at-open order consistently produces better prices than market and limit orders executed during the trading day.

Weak-Form and Semi-Strong-Form Stock Return Predictability Revisited

This paper makes indirect inference about the time variation in expected stock returns by comparing unconditional sample variances to estimates of expected conditional variances. The evidence reveals more predictability as more information is used, and there is no evidence that predictability has diminished in recent years. Semi-strong-form evidence suggests that time variation in expected returns remains economically important.

Intra–day Behavior of Treasury Sector Index Option Implied Volatilities around Macroeconomic Announcements

If option implied volatility is an unbiased, efficient forecast of future return volatility in the underlying asset, then we should be able to predict its path around macroeconomic announcements from responses in cash markets. Regressions show that volatilities rise the afternoon before announcements that move cash markets, and that post-announcement volatilities return to normal as rapidly as cash prices do. Although implied volatilities are predictable, the Treasury options market is efficient since informed traders do not earn arbitrage profits once we account for trading costs.

A Contingent-Claims Approach to the Inventory-Stocking Decision

This paper presents option-pricing solutions to the inventory-stocking problem when demand is distributed discretely or continuously. The model readily incorporates inventory salvage values and stockout costs, and shows that option-pricing models can be used to determine the optimal stocking levels. The contingent-claims approach is a straightforward extension of the traditional inventory framework, and allows the technology of financial economics to be applied to this important class of assets. The conventional approach to inventory decisions relies on an expected profit-maximization criterion, which takes as its starting point a distribution of demand for the inventory item. The starting point for the contingent-claims approach presented here is to associate the demand for an inventory item to the price of an underlying state variable. Inventory payoffs depend on demand and the quantity stocked as well as the selling price, salvage value, and penalties for stockouts. To apply the contingent-claims approach, we construct a portfolio of options that replicates these inventory payoffs, value the portfolio, and then subtract the inventory investment to establish the net present value (NPV) of an inventory policy.

Discretionary Reductions in Warrant Exercise Prices

Managers can decide to reduce a warrants exercise price. A reduction in exercise price can induce exercise (a conversion-forcing reduction) or not (a long-term reduction). Conversion-forcing firms show an abnormal return of -1.53% on the announcement day but they perform well over the three years following the announcement. This finding suggests that the funds raised from warrant exercise are invested in profitable projects. Long-term reductions show an abnormal return of -1.15% on the announcement day. These firms also perform well following the reduction, which suggests that the lower exercise price restores managerial incentives.

An Empirical Test of the Hull-White Option Pricing Model

INTRODUCTIONThe Black-Scholes (1973) option pricing model provides the foundationfor the modern theory of options valuation. In actual applications, how-ever, the model has certain well-known deficiencies. For example, whencalibrated to accurately price at-the-money options the Black-Scholes(1973) model often misprices deep in-the-money and deep out-of-the-money options. This model-anomalous behavior givesrisetowhatoptionsprofessionals call “volatility smiles.” A volatility smile is the skewed pat-tern that results from calculating implied volatilities across a range ofstrike prices for an option series. This phenomenon is not predicted bythe Black-Scholes (1973) model, since volatility is a property of the un-derlying instrument and the same implied volatility value should be ob-served across all options onthatinstrument.Volatilitysmilesaregenerallythought to result from the parsimonious assumptions used to derive theBlack-Scholes model. In particular, the Black-Scholes (1973) model as-sumes that security log prices follow a constant variance diffusion pro-cess. The constant variance assumption has been tested and rejected inearly studies by Beckers (1980), Black and Scholes (1972), Christie

Large price movements and short-lived changes in spreads, volume, and selling pressure

Abstract In this paper we examine changes in dollar and relative bid-ask spreads of stocks following large price movements. We investigate large increases and decreases separately and link our results to current market microstructure theories on trading activities and spreads. We also look at changes in volume and selling pressure to interpret the changes in trading activity. Our results show that the market reacts differently to price increases and decreases. For large price decreases, trading increases on the sell side even when spreads have increased. For large price increases, trading increases on the buy side during a period of higher spreads. However, the increases in dollar spreads and price pressure are most pronounced at the end of trading day. Our results are consistent with microstructure models that link trading activities and costs to the level of asymmetric information.

CFA Certification Program and Sell-Side Analysts

We examine the effects the Chartered Financial Analyst (CFA) designation program has on recommendation performance and career outcomes of the analysts who complete the curriculum and become charterholders. For these analysts, both their recommendation performance and their chances of making the Institutional Investor’s All-America Research Team increase during 1993–2015. These effects are attributable to the CFA program curriculum. The results remain largely stable across the pre- and post-2000 subperiods, and they survive an array of robustness checks.