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Do S&P 500 index options violate the martingale restriction?

✍ Scribed by Strong, Norman; Xu, Xinzhong

Publisher
John Wiley and Sons
Year
1999
Tongue
English
Weight
270 KB
Volume
19
Category
Article
ISSN
0270-7314

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✦ Synopsis

The study tests Longstaff 's martingale restriction on S&P 500 index options over the period 1990-1994. Assuming the S&P index follows a lognormal distribution results in systematic violations of the martingale restriction, the implied index value from options consistently overestimating the market value. Adopting a generalized distribution, allowing for nonnormal third and fourth moments, produces economically insignificant rejections of the martingale restriction. A simulation analysis supports the empirical results from the lognormal model in the presence of nonnormal skewness and kurtosis. Overall, the results support the conclusion that the no-arbitrage assumption coupled with the generalized distribution offers a good working model for S&P index options over the period studied.

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