Modeling Stock Pinning

Marc Jeannin (), Giulia Iori () and David Samuel ()

No 06/04, City University Economics Discussion Papers from Department of Economics, City University, London

Abstract: The paper investigates the effect of hedging strategies on the so called pinning effect, i.e. the tendency of stock’s prices to close near the strike price of heavily traded options as the expiration date nears. In the paper we extend the analysis of Avellaneda and Lipkin (2003) who propose an explanation of stock pinning in terms of delta hedging strategies for long option positions. We adopt a model introduced by Frey and Stremme (1997) and show that in this case pinning is driven by two effects: a hedging dependent drift term that pushes the stock price toward the strike price and a hedging dependent volatility term that constrains the stock price near the strike as it approaches it. Finally we show that pinning can be gnerated by dynamic hedging strategies under more realistic market conditions by simulating trading in a double auction model.

New Economics Papers: this item is included in nep-fmk and nep-mst
Date: Written 2006-05
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Published in Physica A, 376, 467-479 (2007)

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Persistent link: http://EconPapers.repec.org/RePEc:cty:dpaper:0604

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