EMPIRICAL TEST OF MARKET EFFICIENCY OF OMX OPTIONS

Abstract

This thesis examines the market efficiency of the Swedish index option (OMX) market. The empirical tests are carried out on an ex-ante basis using the index future contracts to hedge the index options. Two efficiency tests have been performed, explicitly lower boundary and put call parity conditions test and dynamic hedging strategy. The first test shows that the discovered deviations from the lower boundary conditions and put call parity condition do not generate abnormal returns, particularly after all transaction costs have been accounted for. The second test, delta neutral dynamic hedging strategy, is simulated by comparing option market prices with the Black Scholes prices calculated using two volatility estimators, namely historical volatility (HSD) and weighted implied standard deviation (WISD). The strategy evidences that no systematic abnormal returns can be found in the OMX option market, therefore supporting the hypothesis of no arbitrage opportunity and market efficiency.