Stock Market Efficiency and Price Predictions Implicit in Option Trading

R. L. Brown and T. J. Shevlin
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R. L. Brown: Department of Accounting and Finance, Monash University. For helpful comments on earlier drafts we are grateful to Philip Brown, Graham Peirson, Richard Rendleman and participants in seminars at Monash University, the University of New South Wales and the University of Queensland. We are also grateful to Peter Small of the Options Clearing House (Sydney) for advice on certain details regarding data collection and to the Australian Merchant Bankers Association for providing us with interest rate data.
T. J. Shevlin: Department of Accounting and Finance, Monash University. For helpful comments on earlier drafts we are grateful to Philip Brown, Graham Peirson, Richard Rendleman and participants in seminars at Monash University, the University of New South Wales and the University of Queensland. We are also grateful to Peter Small of the Options Clearing House (Sydney) for advice on certain details regarding data collection and to the Australian Merchant Bankers Association for providing us with interest rate data.

Australian Journal of Management, 1983, vol. 8, issue 2, 71-93

Abstract: The Black-Scholes option pricing model (with approximate adjustments for dividends and exercise price changes) was used to generate stock prices which are “implied†by the model. If the stock market is efficient, these implied prices should not be capable of being used profitably by traders. This hypothesis is tested using prices established in the Australian Options Market and the Sydney Stock Exchange over the period February 1976 to December 1980. A close correspondence is found between implied stock prices and actual stock prices. Tests of the predictive power of the implied prices were unable to discover evidence of market inefficiency. However, a simulated trading strategy executed over one trading day and based on the largest discrepancies between actual and implied prices did meet with some success.

Keywords: BLACK-SCHOLES MODEL; IMPLIED STOCK PRICES; PREDICTIVE POWER; PRICING DISCREPANCIES; STOCK MARKET EFFICIENCY (search for similar items in EconPapers)
Date: 1983
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Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:8:y:1983:i:2:p:71-93

DOI: 10.1177/031289628300800205

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