Abstract
This paper tests the impact of transaction cost specication on deviations from lower boundary and put-call parity properties. Using PHLX traded foreign exchange options, prices for puts and calls are matched to the nearest five minutes. The results indicate how boundaries on the arbitrage profit function determined by alternative measures of transactions costs can impact the interpretation of deviations from distribution free properties of options such as put-call parity.
Highlights
This paper examines the impact of transaction costs on the distribution-free properties of European foreign exchange options traded on the Philadelphia Exchange (PHLX) from Aug. 2005-July 2006
Mean prost ($) for all currencies is calculated as summation of total arbitrage prost ($) for each currency (British pound, Swiss franc and Euro) divided by total number of put-call parity (PCP) deviations for all currencies
In state 3, calls and puts are written OTM and in-the money (ITM), respectively and PCP deviations arise in three possible circumstances: case (i), where call bid price is observed to be higher than put ask; case (ii) where the call bid price is equal to put ask price; and, in case (iii) where the put ask price and call bid price difference is smaller than the difference of present value of strike and spot price
Summary
This paper examines the impact of transaction costs on the distribution-free properties of European foreign exchange options traded on the Philadelphia Exchange (PHLX) from Aug. 2005-July 2006. Deviations from put-call parity (PCP) were examined to determine the role of alternative transaction cost measures. A more formal statistical procedure was employed to test the factors determining deviations from PCP. The results extended previous studies that examined the impact of transaction costs on PCP deviations for stock index options, e.g., Vipul (2008), Garray, Ordonez and Gonzalez (2003) and Wagner, Ellis and Dubofsky (1996), and Hoque, Chan and Manzur (2008) for foreign currency options.
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