Price impact versus bid-ask spreads in the index option market

We investigate the puzzle of why bid-ask spreads of options are so large by focussing on the price impact component of the spread. We propose a structural vector autoregressive model for trades in the option market to analyze whether they move the underlying price and/or the underlying’s volatility. Our model captures cross-option strategies by pooling order flows across contracts after a decomposition into exposure to the underlying asset and its volatility. While our estimates confirm that S&P500 option trades indeed significantly move the underlying and the volatility, the economic magnitudes are very small. Hence, large bid-ask spreads of options remain a puzzle

Non-Standard Errors

In statistics, samples are drawn from a population in a data-generating process (DGP). Standard errors measure the uncertainty in estimates of population parameters. In science, evidence is generated to test hypotheses in an evidence-generating process (EGP). We claim that EGP variation across researchers adds uncertainty: Non-standard errors (NSEs). We study NSEs by letting 164 teams test the same hypotheses on the same data. NSEs turn out to be sizable, but smaller for better reproducible or higher rated research. Adding peer-review stages reduces NSEs. We further find that this type of uncertainty is underestimated by participants

The impact of dark trading and visible fragmentation on market quality

Two important characteristics of current equity markets are the large number of trading venues with publicly displayed order books and the substantial fraction of trading that takes place in the dark, outside such visible order books. This paper evaluates the impact of dark trading and fragmentation in visible order books on liquidity. We consider global liquidity by consolidating the limit order books of all visible trading venues, and local liquidity by considering the traditional market only. We find that fragmentation in visible order books improves global liquidity, whereas dark trading has a detrimental effect. In addition, local liquidity is lowered by fragmentation in visible order books, which suggests that the benefits of fragmentation are not enjoyed by market participants who resort only to the traditional market.dark trading; fragmentation; liquidity; market microstructure