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Title:Essays on the relations between derivatives and underlying asset or commodity markets
Author(s):Wang, Li
Director of Research:Pearson, Neil D.
Doctoral Committee Chair(s):Pearson, Neil D.
Doctoral Committee Member(s):Johnson, Timothy C.; Pennacchi, George G.; Deuskar, Prachi
Department / Program:Finance
Degree Granting Institution:University of Illinois at Urbana-Champaign
Subject(s):Option Trading
Price Efficiency
Derivative Markets
Price Impact
Abstract:This is an empirical study of relations between derivatives markets and their underlying asset or commodity markets. The dissertation consists of three essays. The first essay analyzes the impact of option trading on stock price efficiency around the expirations of IPO lockup agreements. It is well documented that IPO stock prices decline around lockup expirations, without reversals. Investors can exploit these price declines either by short selling in the underlying stock market or by establishing synthetic short positions in the option markets prior to the lockup expiration date. If the existence of option trading relaxes short sale constraints then the prices of optionable stocks should decline earlier (relative to the lockup expiration) than the prices of non-optionable stocks. I find that the prices of optionable IPO stocks experience significant price declines prior to the lockup expirations, while the prices of non-optionable stocks start to decline at and after the expiration dates. In addition, the cumulative (abnormal) order imbalances in the option markets are negative during the ten-day event window prior to the lockup expirations and even more negative when it is difficult to sell short in the underlying stock markets. These results provide direct evidence that derivatives trading helps make the underlying stock market more efficient. The second essay addresses a recent heated debate among academics, practitioners, and regulators about whether financial institutions’ trades and holdings have had important impacts on commodity prices and their return dynamics. This paper uses a novel dataset of Commodity-Linked Notes (CLNs) to examine the impact of the flows of financial investors on commodity futures prices. Investor flows into and out of CLNs are passed to and withdrawn from the futures markets via issuers’ trades to hedge their CLN liabilities. The flows are not based on information about futures price movements, but nonetheless cause increases and decreases in commodity futures prices when they are passed through to and withdrawn from the futures markets. These finding are consistent with the hypothesis that non-information based financial investments have important impacts on commodity prices. The third essay investigates one mechanism by which derivatives markets affect the prices of their underlying stocks. Issuers of structured equity products (SEPs) based on common stocks hedge their liabilities by trading in the underlying common stocks. In the sample used in this paper, these trades raise the prices of the underlying stocks by an average of almost 100 basis points on the pricing dates of the SEPs. This is direct evidence that derivatives’ hedging has important impacts on the prices of even very large and liquid stocks. The price impact is mostly, but not fully, reversed on the subsequent trading day. In addition, these results provide new estimates of the price impact of trading volume for large-capitalization U.S. common stocks.
Issue Date:2015-04-24
Rights Information:Copyright 2015 Li Wang
Date Available in IDEALS:2015-07-22
Date Deposited:May 2015

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