TITLE:
Are Mispricings Long-Lasting or Short-Lived? Evidence from S & P 500 Index ETF Options
AUTHORS:
Feng Jiao
KEYWORDS:
Stochastic Dominance, Index Option, High-Frequency Trading
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.3,
February
12,
2018
ABSTRACT: A rapidly
growing literature has documented evidences suggesting the mispricing of
options. Building on recent results of option pricing bounds imposed by
stochastic dominance, this paper examines the time-series proprieties of such
mispricing. In an application to high-frequency bid/ask quotes of S & P 500 index ETF options, this
paper provides evidences that most violations of the stochastic dominance bounds last
no more than 10 trading hours. The typical duration of mispricing is even
shorter for near to maturity options. The results imply that the observed
widespread mispricing in options might be the result of temporary inefficiency
(e.g. transaction costs, overreaction, liquidity etc.) rather than a model
misspecification, such as estimation biases of the parameters, or an overlooked
persistent risk factor.