Essays on asset pricing under market constraints

Abstract

This thesis consists of three essays. The first essay provides a rational explanation of asymmetric violations of put?call parity; that is, an explanation for why, under short sales constraints, stock prices tend to be higher than the synthetic stock prices derived by option prices. To provide this explanation, a discrete time option pricing framework is set up under short sales constraints, and it is shown that a stock price above the synthetic stock price does not represent a true violation, since the costs of short?selling are unpredictable and can be enormously high. From the empirical analysis, it is found that violations of put?call parity are rare, and that investors across the stock and the options markets are rational and correctly take the constraints into account. The second essay empirically shows that discretely hedged S&P 500 index option portfolios are exposed to covariance and coskewness risk with the market portfolio. Dynamic replicating assumption of no arbitrage option pricing models does not hold in practice due to discreteness of trading hours as well as trading costs, which suggests the potential presence of performance?driven risk premia. Using the three?moment CAPM of Kraus and Litzenberger (1976), it is shown that the rate of return of the portfolio significantly loads on the two risk factors, and that their risk premia are significantly positive. The equilibrium model complements the prevailing approach of the no arbitrage framework, and reveals that the volatility smile is linked to investors’ preference on the unhedged market risks. The third essay examines an asset pricing test on individual stock options. While it is investigated that discretely hedged S&P 500 index option portfolios are exposed to covariance and coskewness risks with the market portfolio, whether hedge portfolios of stock options behave in the same way has not been revealed. Using the three?moment CAPM of Kraus and Litzenberger (1976), it is found that there a...