Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets

Eli Ofek, Matthew Richardson and Robert F. Whitelaw

No 9423, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper, we investigate empirically the well-known put-call parity no-arbitrage relation in the presence of short sale restrictions. We use a new and comprehensive sample of options on individual stocks in combination with a measure of the cost and difficulty of short selling, specifically the spread between the rate a short-seller earns on the proceeds from the sale relative to the standard rate (the rebate rate spread). We find that violations of put-call parity are asymmetric in the direction of short sales constraints, their magnitudes are strongly related to the rebate rate spread, and they are maintained even in the presence of transactions costs both in the options and equity lending market. These violations appear to be related to both the maturity of the option and the level of valuations in the stock market, consistent with a behavioral finance theory that relies on over-optimistic investors in the stock market and segmentation between the stock and options markets. Moreover, the extent of violations of put-call parity and the rebate rate spread for individual stocks are significant predictors of future stock returns. For example, cumulative abnormal returns, net of borrowing costs, over a 2«-year sample period can exceed 65%.

JEL-codes: G13 G14 (search for similar items in EconPapers)
Date: 2003-01
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-rmg
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

Published as Whitelaw, Robert F., Eli Ofek, and Matthew Richardson. “Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets." Journal of Financial Economics 74, 2 (2004): 305-342.

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