Is the KOSPI 200 Options Market Efficient? Parametric and Nonparametric Tests of the Martingale Restriction


  • Qian Han's research work is supported by the Central University Research Grant (no. 2011221015) and Fujian Provincial Natural Science Foundation (no. 2011J05009). The authors are grateful for the helpful comments and suggestions from Robert I. Webb (the Editor), Calum G. Turvey, Ying Fang, Haiqiang Chen, Joseph Fung, Eunyoung Kim (the Discussant), the anonymous referee, and the seminar participants at the 7th Asia-Pacific Association of Derivatives (APAD) conference.

Correspondence author, Room A402, Economics Building, Wang Yanan Institute for Studies in Economics, Xiamen University, Xiamen 361005, China. Tel: +86-592-2180969, Fax: +86-592-2187708, e-mail:

**Correspondence author, School of Economics, College of Business and Economics, Chung-Ang University, Heukseok-dong, Dongjak-gu, Seoul 156-756, South Korea. Tel: +82-2-820-5495, Fax: +82-2-813-5487, e-mail:


A number of studies on the S&P 500 index options market claim that the no-arbitrage assumption cannot be rejected for this market because either the martingale restriction defined in Longstaff (1995) cannot be rejected by the data, or, even when it is rejected, a large proportion of the violation can be explained by market friction factors. The present study singles out the effect of market inefficiency from market friction by testing the martingale restriction for the KOSPI 200 index options market, which is the most liquid and active options market in the world. Not only using the parametric methods adopted in previous studies but also using the nonparametric methods that enable us to avoid the model misspecification problem, we empirically present clear evidence of a violation of the martingale restriction. In addition, in contrast to the S&P 500 options market, regression analyses and robustness tests indicate that market friction factors can explain only a small portion of the percentage differences between option-implied and market-observed index prices. Overall, the results do not support the basic no-arbitrage assumption or the market efficiency in the KOSPI 200 options market.