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The Babushka Lady in 2008 financial crisis : price discovery role of equity options

English Abstract

This thesis provides first set of empirical results on option markets microstructure issues during crisis to the literature. By focusing on intra-day liquidity provision and equity price discovery in options markets, we show significant option market trading activities prior to Lehman Brother’s bankruptcy announcement, which indicates informed traders do trade in option markets. According to Kyle (1985)’s definition of liquidity, this thesis investigates option markets liquidity during crisis from three aspects, namely, spread, depth, and resilience. It finds option markets demonstrated U-shaped percentage spread and reversed U-shape depth to cope with higher informational uncertainty in the open and close section every day. For the resilience, it’s observed that options liquidity spikes when shocks come, and it response as fast as equity markets. The liquidity spikes delay documented by Engle and Neri (2010) no longer exists. The results suggest option markets quality improvement in past few years. On 15th of September, percentage spread in option market increases 43.377%, which is about one-fourth of 159.005% increase in equity market. Our analysis suggests option markets suffered less liquidity dry-up than equity markets from these shocks in percentage basis. The equity price discovery analysis shows option markets are the multi-channel system for discovering equity prices. Different option contracts contribute to equity price discovery simultaneously. Our results suggest away from expiries option contracts discovery more information than close to expiries options, which confirms Whaley’s (2000) argument that options’ implied volatility reflect information for the period matches with its expiry. In addition we find that Long-term Equity AnticiPation Securities 4 (LEAPs) incorporates more information during crisis. We also show at-the-money option contracts discover more information than other moneyness contracts, and have the highest likelihood to be the most informative option contracts. Our result is in contrast with Black (1975) conjecture that informed traders prefer out-ofmoney contracts because of their leverage. Last but not least, we uncover that significant more information in the subjective finance group is discovered via put options on the day the short-sell-ban is imposed by Security Exchange Committee (SEC). The concrete evidence shows government policy during crisis moves informed traders from other markets to option markets. Overall this thesis provides a comprehensive analysis of liquidity provision by equity option markets and price discovery role of various option contracts. Not only providing new evidence makes the non-redundant-option-market argument more complete, this thesis shed new light on option market microstructure during the recent financial crisis.

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Cao, Wei Yue


Faculty of Business Administration


Department of Finance and Business Economics


M. Sc.


Financial crises -- Asia

Securities -- Prices


Cheung, Ming Yan

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