Efficiency Tests of the Foreign Currency Options Market




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    • The Ohio State University and New York University, respectively. This study could not have been undertaken without the efforts of Arnie Staloff of the Philadelphia Stock Exchange. Comments on a previous draft of the paper by the participants in the Ohio State University Economics/Finance Colloquium and in the 1984 European Finance Association Meetings are gratefully acknowledged. Specific comments by J. Huston McCulloch, Rene Stulz, and an anonymous referee of this journal have been particularly helpful in the revision of this work. This work has been supported by a grant from the School of Administrative Science at Ohio State University. All errors and omissions are the authors' responsibility.


Based on a new options transactions data base from the Philadelphia Stock Exchange Foreign Currency Options Market, this paper examines the importance of the effect of nonsynchronous prices and transaction costs on the usual option market efficiency tests. The tests conducted are based on the transaction cost adjusted early exercise and put-call parity pricing boundaries applicable to the American foreign currency options market. The test results show that the put-call parity boundary tests are sensitive to both nonsynchronous prices and transaction costs. The early exercise boundary tests are sensitive to transaction costs but are not very sensitive to simultaneity of the option price and the underlying spot price. Under the no-transaction costs scenario, a large number of early exercise boundary violations is found even when simultaneous spot and option prices are used. These violations disappear when actual transaction costs are taken into account.