NDLI: Idiosyncratic Volatility and Stock Returns: Does Option Trading Reduce Stock Market Mispricing?

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Idiosyncratic Volatility and Stock Returns: Does Option Trading Reduce Stock Market Mispricing?

Content Provider	Semantic Scholar
Author	Elkamhi, Redouane Lee, Yong Ii Yao, Tong
Copyright Year	2009
Abstract	Theory suggests that options may play an important role in improving information efficiency of financial markets. This study empirically examines whether option trading reduces stock market mispricing in the form of the idiosyncratic volatility (IVOL) anomaly, i.e., the negative relation between idiosyncratic volatility and future stock returns. We find that the IVOL anomaly is intensified rather than reduced among stocks with active option trading, and that options of these stocks exhibit a similar magnitude of mispricing. We further document that the magnitude of the IVOL anomaly is positively correlated with two measures of relative option trading activity – the ratio of option trading volume to stock trading volume and the ratio of option open interest to stock trading volume. In addition, there is a stronger negative relation between IVOL and future earnings surprises among stocks with higher relative option trading activities. These findings are consistent with a hypothesis that some option traders have private information about future stock returns, and that such private information is first revealed in option trading activity before being incorporated into option prices or stock prices. JEL Classification: G10; G12; G13.
File Format	PDF HTM / HTML
Alternate Webpage(s)	https://www.edwards.usask.ca/centres/csfm/_files/presentations/yong%20lee.pdf
Language	English
Access Restriction	Open
Content Type	Text
Resource Type	Article

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