Market depth, domestic investors and price monotonicity violations

ABSTRACT

We re-examine the monotonicity violations of option price dynamics considering the roles of market depth and domestic investors. Violations caused by option price movements in conflict with underlying price movements tend to occur less frequently as the market depth increases, especially in the case of out-of-the-money options. In contrast, violations caused by option prices that remain sticky despite underlying price changes occur more frequently as the market depth increases. Both of these relationships are amplified by domestic investors.

KEYWORDS:

• Domestic investors
• KOSPI200 options
• market depth
• market microstructure
• price monotonicity

JEL CLASSIFICATION:

• G13
• G15

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Bakshi, Cao, and Chen (2000) and Yang, Choi, and Ryu (2017) also explain why the price monotonicity properties should hold in generalized settings, including multi-factor stochastic volatility models.

² In the KOSPI200 options market, domestic investors prefer to trade in OTM options because OTM options offer the greatest leverage and have lottery-like properties, which implies that the KOSPI200 OTM options market is more speculative (Kim and Ryu 2015; Ryu 2015).

Additional information

Funding

This work was supported by the Ministry of Education of the Republic of Korea and the National Research Foundation of Korea [NRF-2017S1A5A2A01025583].