Review of Finance Advance Access originally published online on August 23, 2007
Review of Finance 2007 11(3):497-525; doi:10.1093/rof/rfm021
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Liquidity and Arbitrage in Options Markets: A Survival Analysis Approach*
1 CRNS and Paris Dauphine University
2 Paris Dauphine University and DRM
This paper examines the determinants of the time it takes for an index options market to return to no arbitrage values after put-call parity deviations, using intraday transactions data from the French index options market. We employ survival analysis to characterize how limits to arbitrage influence the expected duration of arbitrage deviations. After controlling for conventional limits to arbitrage, we show that liquidity-linked variables are associated with a faster reversion of arbitrage profits. The introduction of an Exchange Traded Fund also affects the survival rates of deviations, but this impact essentially stems from the reduction in the level of potential arbitrage profits.
* We gratefully acknowledge the comments and suggestions from Bruno Biais, Hazem Daouk, Thierry Foucault, Christine Parlour, Myron Slovin and Marie Sushka. We would like to thank seminar participants at the 2004 Toulouse Master in Finance Inaugural Conference, the Europlace Institute of Finance November 2004 Research Days, the French Finance Association 2004 Annual Meeting, the FMA 2005 European conference, the 2006 Konstanz International Conference on High-Frequency Finance and the 2006 Banque de France Microstructure of Financial and Money Markets conference. We would also like to thank the editor, Marco Pagano, and an anonymous referee for insightful suggestions. The authors benefitted from the financial support of the Europlace Institute of Finance. The usual disclaimer applies.