Pricing and Informational Efficiency of the MIB30 Index Options Market. An Analysis with High Frequency Data

Abstract

We analyze the pricing and informational efficiency of the Italian market for options written on the most important stock index, the MIB30. We report that a striking percentage of the data consists of option prices violating basic no-arbitrage conditions. This percentage declines when we relax the no-arbitrage restrictions to accommodate for the presence of bid/ask spreads and other frictions, but never becomes negligible. We also investigate the informational efficiency of the MIBO and conclude that option prices are poor predictors of the volatility of MIB30 returns. This conclusion is robust to a number of statistical and sampling methods. * We wish to thank Alberto di Stefano from BSI (Banca della Svizzera Italiana) who has made available the data used in this paper. We are also grateful to Giovanni Barone-Adesi, Laura Cavallo, Paolo Mammola, and seminar participants at Bocconi University, University of Southern Switzerland, and Tilburg University. Of course, the contents of the paper remain the sole responsibility of the authors.

Modelling the implied volatility surface: Does market efficiency matter?

“…9 Since in a companion paper (Cassese & Guidolin, 2004) we investigate this aspect in detail, for the current purposes we limit ourselves to a small set of key points.For frictionless options markets the absence of arbitrage is equivalent to the following pricing rules:…”

“…10 For the sake of simplicity, we will assume throughout that the interest rate r is constant. 11 Cassese and Guidolin (2004) also discuss the potential role of other types of frictions. Microstructural features of the IDEM, cash dividends, and taxation as possible determinants of arbitrage violations.…”

“…Then the bid/ask spread is 2a and 2b for options and the MIB30, respectively. Under these assumptions, Cassese and Guidolin (2004) For instance, in the presence of frictions the standard lower bound condition is represented by the following inequalities…”

“…Nevertheless, even the more liquid segments of the market tend to display ratios above 30%, i.e. 13 See Cassese and Guidolin (2004) for further details on how these conditions are checked. For most of them, textbook treatments are available.…”

“…Capelle-Blancard and Chaudury (2001), Mittnik and Rieken (2000), Nikkinen (2003), Peña et al (1999), and Puttonen (1993) have recently stressed the importance of studying the efficiency and pricing mechanisms of such relatively less developed stock index option markets. A related paper is Cassese and Guidolin (2004) who study MIB30 index options, but does not consider the importance of market efficiency for both the econometrics of the MIBO IVS and for practical financial decisions.…”