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SPATIAL DEPENDENCE IN OPTION OBSERVATION ERRORS

Published online by Cambridge University Press:  13 April 2020

Torben G. Andersen ,
Nicola Fusari ,
Viktor Todorov  and
Rasmus T. Varneskov
Torben G. Andersen*
Affiliation:
Northwestern University, NBER, CREATES
Nicola Fusari
Affiliation:
The Johns Hopkins University Carey Business School
Viktor Todorov
Affiliation:
Northwestern University
Rasmus T. Varneskov
Affiliation:
Copenhagen Business School, CREATES, Multi Assets at Nordea Asset Management
*
Address correspondence to Torben G. Andersen, Department of Finance, Kellogg School of Management, Northwestern University, Evanston, IL 60208, USA; e-mail: t-andersen@northwestern.edu.
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Abstract

In this paper, we develop the first formal nonparametric test for whether the observation errors in option panels display spatial dependence. The panel consists of options with different strikes and tenors written on a given underlying asset. The asymptotic design is of the infill type—the mesh of the strike grid for the observed options shrinks asymptotically to zero, while the set of observation times and tenors for the option panel remains fixed. We propose a Portmanteau test for the null hypothesis of no spatial autocorrelation in the observation error. The test makes use of the smoothness of the true (unobserved) option price as a function of its strike and is robust to the presence of heteroskedasticity of unknown form in the observation error. A Monte Carlo study shows good finite-sample properties of the developed testing procedure and an empirical application to S&P 500 index option data reveals mild spatial dependence in the observation error, which has been declining in recent years.

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Type
ET LECTURE
Information
Econometric Theory , Volume 37 , Issue 2 , April 2021 , pp. 205 - 247
Copyright
© Cambridge University Press 2020

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Footnotes

T.G.A. and R.T.V. gratefully acknowledge support from CREATES, Center for Research in Econometric Analysis of Time Series (DNRF78), funded by the Danish National Research Foundation. The work is partially supported by NSF Grant SES-1530748. We would like to thank the Editor (Peter C.B. Phillips) and two anonymous referees as well as participants at the 2019 SETA conference in Osaka, Japan for useful comments and suggestions.

References

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