Sponsored by TabbFORUM
28 January 2011
White Paper: ISDA Study: Transparency in OTC Equity Derivatives Markets: a Quantitative Study
We study trade-transparency in over-the-counter (OTC) equity derivatives markets, performing two related experiments. The first consists of a statistical study: we analyze a very large dataset of reported OTC transactions to the MarkitServ database and seek to correlate the trade prices with the prices of analogous derivatives listed in exchanges or with model prices derived from the latter (\fair value prices"). The second part consists in conducting Live Quote Experiments, in which we partner with two rms to request rm live quotes from multiple dealers. Quotes are requested for a list of transactions that we designed beforehand. The dealers involved did not know that this was an experiment and returned with two-way quotes on the list of trades, which were recorded along with contemporaneous quotes from listed markets corresponding to similar strikes and maturities.
The statistical study indicates that (i) price-to-fair-value discrepancies are found to be within one or two bid-oer spreads with 95% condence. (ii) Transactions involving end-users are no further away from fair value than analogous dealer-to-dealer trades on average. Thus the statistical study suggests that end-users trading with dealers are not at a signicant informational disadvantage.
Live quote experiments give even better results in this direction. They indicate only very minor dispersion of quotes among dealers (i.e. most dealers quote similar prices) and tight bid-ask spreads. Discrepancies between dealer quotes and contemporaneous listed implied volatilities are less than 1%, when considering all the data and products pooled together.
The results indicate a very reasonable level price-discovery in OTC equity derivatives markets, due to the strong link that exists between OTC prices and information available from listed options exchanges.
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