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Put–Call Parity Violations Under Limited Arbitrage: A Case Study and a Simulation Tool for Detecting Financial Irregularity

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Abstract

We use simulated data to examine the ability of standard statistical tests to detect the presence of price pressure resulting from attempts to manipulate the stock options market. We find limited ability of difference tests to detect anomalous price pressure in cases where limits to arbitrage are absent or the degree of price pressure is low and when the anomalous price pressure occurs for a short period relative to the overall window analyzed. To help with pedagogical use of our method, we provide a detailed case study of Porsche’s takeover attempt of Volkswagen (VW). The case study helps students to devise classroom tools for detecting and taking timely actions against financial misconduct.

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Notes

  1. 1.

    See Barberis and Thaler (2003) and Shleifer and Vishny (1997) for a comprehensive review of limits to arbitrage.

  2. 2.

    This approach may be useful as a preliminary identification strategy that can then be corroborated by a financial regulator who examines matched order flow data. It is also the only option for market participants who do not have access to matched order flow data.

  3. 3.

    This enables us to omit δ without losing generality in the analysis of differences. To generalize this approach to American options on stocks paying a discrete dividend, we would need to consider a parametrization of the early exercise premium, a consideration beyond the scope of this work.

  4. 4.

    Identical results, though with reversed sign on the PCP gap, can be obtained by increasing the price pressure and IV on the at-the-money put option.

  5. 5.

    In the presence of IID normal shocks to c and p introduced by noise traders, this may be a reasonable assumption.

  6. 6.

    The observable strength of anomalous price pressure would be moderated by the ability of arbitrageurs to absorb it, i.e., the limits to arbitrage.

  7. 7.

    Naked short selling was legal at the time in Germany.

References

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Correspondence to Ted Azarmi .

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© 2016 Springer International Publishing Switzerland

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Azarmi, T., Borochin, P. (2016). Put–Call Parity Violations Under Limited Arbitrage: A Case Study and a Simulation Tool for Detecting Financial Irregularity. In: Azarmi, T., Amann, W. (eds) The Financial Crisis. Springer, Cham. https://doi.org/10.1007/978-3-319-20588-5_6

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