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The Effects of Stochastic Volatility and Demand Pressure on the Monotonicity Property Violations

Ging-Ginq Pan, Yung-Ming Shiu and Tu-Cheng Wu
The Journal of Derivatives Fall 2014, 22 (1) 90-102; DOI: https://doi.org/10.3905/jod.2014.22.1.090
Ging-Ginq Pan
is an associate professor at the Graduate Institute of Finance at National Pingtung University Science and Technology in Pingtung, Taiwan.
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  • For correspondence: ggpam@mail.npust.edu.tw
Yung-Ming Shiu
is a professor in the Department of Risk Management and Insurance, and also a researcher at the Risk and Insurance Research Center at National Chengchi University in Taipei, Taiwan.
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  • For correspondence: yungming@nccu.edu.tw
Tu-Cheng Wu
is an associate professor in the Department of Applied Mathematics, I-Shou University in Kaohsiung County, Taiwan.
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  • For correspondence: tucheng@isu.edu.tw
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Abstract

A bothersome empirical finding in the options market microstructure literature is that in a small but significant percentage of the cases, market prices for a call and for its underlying stock move in opposite directions. For example, the stock price falls, but the call goes up, which is a violation of options’ monotonicity property. Using detailed intraday data on the Taiwan TAIEX index and its options, the authors find violations of monotonicity in about one third of the trades. They consider two possible factors that might push the call (put) price in a different (the same) direction as the stock: stochastic volatility, which introduces a second variable with its own dynamics into option pricing, and demand pressure from trades like covered calls, which can have opposite impacts on the stock and the option. The two factors together can explain all but 18% of the monotonicity violations in the data.

TOPICS: Options, emerging

  • © 2014 Institutional Investor, Inc.
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The Journal of Derivatives: 22 (1)
The Journal of Derivatives
Vol. 22, Issue 1
Fall 2014
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The Effects of Stochastic Volatility and Demand Pressure on the Monotonicity Property Violations
Ging-Ginq Pan, Yung-Ming Shiu, Tu-Cheng Wu
The Journal of Derivatives Aug 2014, 22 (1) 90-102; DOI: 10.3905/jod.2014.22.1.090

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The Effects of Stochastic Volatility and Demand Pressure on the Monotonicity Property Violations
Ging-Ginq Pan, Yung-Ming Shiu, Tu-Cheng Wu
The Journal of Derivatives Aug 2014, 22 (1) 90-102; DOI: 10.3905/jod.2014.22.1.090
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  • Article
    • Abstract
    • DEFINITION OF MONOTONICITY PROPERTY VIOLATION
    • EMPIRICAL DESIGN AND DATA
    • STOCHASTIC VOLATILITY
    • DEMAND PRESSURE
    • MONOTONICIY PROPERTY VIOLATIONS
    • UNIVARIATE ANALYSIS
    • REGRESSION ANALYSIS
    • CONCLUSION
    • ENDNOTES
    • REFERENCES
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