Options in emerging markets.

Abstract

Index options are traded in many derivatives markets around the world. These derivatives markets can either operate in efficient or inefficient markets. Most derivatives markets use the best known option pricing model, i. e. the Black and Scholes Option Pricing Model, in order to produce theoretical option prices. However, the model itself assumes that the markets are efficient so that theoretical prices do not differ significantly from market prices. But what is happening in emerging markets? Emerging markets are characterized by many anomalies, which may create problems either to the model or in general to the fair option pricing. This study is concerned with the Athens Stock Exchange and the Athens Derivatives Exchange. Specifically, this research tests the at-the-money index call options on the FTSE/ASE 20 index with two months to expiration. The Greek market is an `emerging' market and this research tries to show that the Black and Scholes model is not an appropriate model for the Athens Stock Exchange or, more generally, for emerging markets, due to its assumptions. Additionally, the research tries to identify market anomalies and to test whether these anomalies have a significant effect on the market option prices. The thesis includes a review of empirical studies on stock and option markets and on the Black and Scholes model. The conclusions of these studies suggest that there are several market anomalies in stock markets that affect option prices. Furthermore, there are many criticisms that can be leveled against the Black and Scholes model and its assumptions. In order to identify the market anomalies and option mis-pricing, we employ a battery of statistical tests. The test results tend to support the previous empirical studies and suggest that the Athens Stock Exchange suffers from several anomalies. The results also indicate the inefficient status of the market. In addition, the Black and Scholes model creates pricing problems in the Greek market. These pricing problems are due to the stock market anomalies and the mis-estimation of the true (historic) volatility from the implied volatility. The final part of the thesis shows the significant effect that the stock market anomalies have on option prices. Market anomalies, such as mis-estimation of the historic volatility, asymmetric information, insider trading and low market depth, have a significant effect on option prices. Adding these anomalies to the Black and Scholes model, we are able to construct a model that can predict market option prices more reliably.