Potential Biases from Using Only Trade Prices of Related Securities on Different Exchanges: A Comment

Abstract

equilibrium prices of the underlying stocks using daily (trade) prices. This paper points out that a bias associated with the bid-ask spread and nonsynchronous trading may create the impression that option prices contain information not reflected in the contemporaneous stock prices even during times when the two prices are in equilibrium. The MR methodology is described in Section I, and the potential biases arising due to the bid-ask bounce and the non-synchroneity of stock and option prices are illustrated in Section II. Following an observation in their paper that the stock prices implied by the option prices are smaller than the corresponding stock prices only thirty-seven percent of the time, Section III looks at the distribution of trade prices relative to the last quoted bid-ask prices for both stocks and options. Many more during-the-day option trades occur at the ask than at the bid, whereas the distribution is approximately symmetric for stocks. A likely implication is that the option trade prices, and therefore the implied stock prices, are upward-biased estimates of the corresponding true prices.' This bias increases at day end for both stocks and options.