Academic journal article International Journal of Business

Volume, Volatility, Spreads and Periodic Closure in the French Market

Academic journal article International Journal of Business

Volume, Volatility, Spreads and Periodic Closure in the French Market

Article excerpt

ABSTRACT

This paper studies the effects of opening and closing on transactions demand, volume, volatility and the bid-ask spreads of options prices and their underlying assets. This question is studied in Brock and Kleidon (1992), Smith and Webb (1994), Hsieh and Kleidon (1996), Hong and Wang (2000), among others. An extension of the models in Merton (1971), Garman (1976) and Bellalah and Zhen (2002) is used and the empirical implications of our model are studied. We show that transactions demand at open and close in options markets and the underlying assets markets are greater than at other times of the day. The study reveals that periodic market closure leads to periodic changes in the demand for transaction services and reveals the presence of an increased demand and less elastic transactions around closure. The predictions of periodic demand with high volume and narrow spreads in options markets are not always consistent with empirical evidence on the Paris Bourse. In fact, the results depend on the length of the time interval chosen at the open and the close and the degree of synchronization of options prices and the underlying assets prices.

JEL: G1, G12, G13, G14, G15, F3

Keywords : Volume; Volatility; Periodic market closure

1. INTRODUCTION

Stocks on the Paris-Bourse are traded in a market where settlements take place periodically on a given date as in the U.K. (1) MONEP traded options are quoted on a continuous basis on a screen trading system. (2) Before 1999, there was a dual quotation for stock options and index options. (3) The quote information disseminated to the public during the open period concerns the bid and offer prices. This information is no longer disseminated in the close period and there is an abrupt change from a regime of continuous trading to a regime of no trading. The question of how the trading behavior at open and close is affected in financial markets is analyzed in Admatti and Pfeiderer (1988), Brock and Kleidon (1992), Smith and Webb (1994), Hsieh and Kleidon (1996), Hong and Wang (2000), Bellalah and Zhen (2002) among others. (4)

This paper gives an answer to a similar question in options markets and their underlying assets markets in a slightly different context. There are several reasons explaining periodic trading demand shifts at the open and the close of the trading, most of which are based on the effect of the periodic inability to trade. We analyze some of these reasons and show that there is a greater demand to trade at open and close than the other times of the trading day. The inability to trade modifies the optimal portfolio of investors.

Following "standard" theory, we examine the reaction of a specialist market maker. Therefore, a model of periodic market closure is presented, which is an extension of the models in Garman (1976), Brock and Kleidon (1992) and Bellalah and Zhen (2002). The model accounts for periodic changes in transactions demand in options markets and provide conditions under which higher transactions imply narrower bid and ask spreads. This is because an increase in the trading activity reduces the spread and converges market prices toward fair options prices. However, lower spreads does not mean necessarily fair option prices since it refers mainly to a low cost of trading. Even if the general question of whether increased trading volume (around closure) is associated with narrowing or widening the bid-ask spread in options is of some interest, it is fundamental to the understanding of how markets work at special points in time. The empirical evidence gives some support to the implications of the model. We find that volume traded in the MONEP is concentrated at open and close. Also, that narrower bid-ask spreads are in general associated to times of high volume on the options market.

The principal empirical results of this paper are that:

(1) There may not be greater demand just at the open of trading in the option market relative to the middle of the day; and (2) High transactions demand at the close of trading in the option market need not coincide with narrower bid/ask spreads. …

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