Equity Options and the Underlying Stocks' Pricing Efficiency : Evidence from the TSE

Theories predict that introduction of option trading should affect the pricing efficiency in the underlying stock market. We further test this hypothesis, employing a recent sample of equity option listings on the Tokyo stock exchange. Using two conventional statistical tests, we find that, with the introduction of options, returns to the underlying stocks become significantly more random and, thus, less predictable, even after controlling for marketwide randomness shifts in the concurrent period. Insofar as randomness proxies for efficiency, these results suggest that initiation of options enhances pricing efficiency for the underling stocks, supporting the hypothesis. This finding is not affected by the endogenous nature of option listing or its liquidity effect