A test of efficiency for the S&P 500 index option market using the generalized spectrum method

Huang, Henry H., Wang, Kent and Wang, Zhanglong (2016) A test of efficiency for the S&P 500 index option market using the generalized spectrum method. Journal of Banking and Finance, 64 52-70. doi:10.1016/j.jbankfin.2015.11.007


Author Huang, Henry H.
Wang, Kent
Wang, Zhanglong
Title A test of efficiency for the S&P 500 index option market using the generalized spectrum method
Journal name Journal of Banking and Finance   Check publisher's open access policy
ISSN 0378-4266
1872-6372
Publication date 2016-03-01
Year available 2015
Sub-type Article (original research)
DOI 10.1016/j.jbankfin.2015.11.007
Open Access Status Not Open Access
Volume 64
Start page 52
End page 70
Total pages 19
Place of publication Amsterdam, Netherlands
Publisher Elsevier
Language eng
Abstract This paper examines the efficiency of the S&P 500 options market by testing the martingale properties of the Model-Free Forward Variance (MFFV) time series using the Generalized Spectral Test (GST). Based on a sample from January 1, 1996 to May 31, 2010, our tests show robust evidence that the S&P 500 options market is not efficient. By examining the subsamples before and after the 2008 financial crisis, we find this options market inefficiency is mainly driven by the outbreak of the subprime crisis. Our diagnostic tests further indicate that this inefficiency is due to the skewness-in-mean effect of forward variance. Specifically, the skewness-in-mean effect is weakened once we account for the S&P 500 index jump effects. Hence, we can establish a link between jumps and options market inefficiency. Finally, we find that the lagged skewness of the forward variance can help forecasting the forward variance both in-sample and out-of-sample. The economic significance of this forecasting ability is further highlighted by the performance of a trading strategy based on forward variance. In sum, out study provides robust evidence and a trading implication on testing the S&P 500 options market efficiency.
Keyword Index jump
Market efficiency
Model-Free Forward Variance
Spectral density test
Q-Index Code C1
Q-Index Status Provisional Code
Institutional Status UQ
Additional Notes Published online 24 December 2015

Document type: Journal Article
Sub-type: Article (original research)
Collections: Official 2016 Collection
UQ Business School Publications
 
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