(An) empirical analysis of the price discovery, the pricing bias, and information flow of the KOSPI 200 index derivatives markets

Abstract

In this thesis, Korean financial markets are investigated in two ways, time series and cross sectional data analysis for the study of market microstructure of price discovery and pricing bias associated with securities, futures and options. First, the lead-lag relationships among the KOSPI 200 stock index, the index futures, and the index options markets are explored based on minute-tominute price data. This thesis examine the price discovery function with the lead-lag relationship for the KOSPI 200 stock index, futures and options over 2 years and 3 months, from May 2001 to June 2003. The results show that the KOSPI 200 stock index futures lead the index by 23 minutes as reported in the previous studies. The stock index lags the at-the-money call options and atthe-money put options by 9 minutes and 5 minutes respectively. The lead-lag relationship between the index or futures markets is similar both to in-themoney and to out-of-the-money options. A symmetric lead-lag relationship has been found between the futures and options except out-of-the-money options. This results support the trading cost hypothesis suggested by Fleming, Ostdiek, and Whaley (1996) which argue that the derivative markets give the investors much lower trading costs than the index stock markets. Besides, the lead-lag relationships between the markets are in accordance with the leverage effect hypothesis arguing that the derivatives markets should lead the stock index markets. Informed traders in the KOSPI 200 stock index and its derivatives markets may react faster to stock index derivatives markets than to the index markets using the leverage effect and lower transaction costs. The trading volume and the trading size support this. In particular, the sufficient trading volume in the deep-in-the-money options provides strong evidence for the proposition. The infrequent trading effect can be found in the (deep) out-of-themoney options. The relatively larger option tick appears to prevent inv...