The Informational Value of Consensus Prices : Evidence from the OTC Derivatives Market

This paper provides empirical evidence on the ability of consensus prices to reduce valuation uncertainty in the over-the-counter market for financial derivatives. The analysis is based on a proprietary data set of price estimates for S&P500 index options provided by major broker-dealers to a consensus pricing service. We develop and estimate a model of learning about fundamental asset values from consensus prices. The panel dimension of the data set allows us to estimate Bayesian updating dynamics at the individual broker-dealer level. We find that uncertainty about index option values, as measured by the variance of broker-dealers' posterior beliefs about the options' fundamental value, is substantial across the volatility surface of S&P500 index options that are traded over-the-counter. The 95% confidence intervals around posterior means can be as large as 10 volatility points for index options with strike prices that correspond to extreme moves of the S&P500 index. Having access to consensus pricing data is found to significantly reduce broker-dealers' strategic uncertainty, that is uncertainty about the positioning of their option valuations in relation to other market participants' valuations