This paper investigates the flow of information between the equity and options markets. We argue that informed traders, in deciding where to place their trades, are not entirely indifferent to option moneyness, degree of information asymmetry, and option liquidity. Unlike some previous studies that find information to flow unilaterally from equity to options markets, we control for the above factors and discover feedback relations between trades in out‐of‐the‐money (OTM) options and the underlying equities. The finding is consistent with the pooling equilibrium hypothesis, which asserts that informed traders trade in both the equity and options markets. Some informed traders are probably attracted to the out‐of‐the money options because of their higher liquidity, lower premiums, and higher delta‐to‐premium ratios, hence, lending support to the liquidity and leverage hypothesis.
"The evidence we uncover suggests that the practice of profit and risk sharing among keiretsu firms reduces the firm level idiosyncratic risk. However, rather than eliminating firm-level risk, it is being transformed into market-level risk. Since market-level risk is priced, this actually destroys shareholders' wealth. Additionally, the heightened correlation among keiretsu firms essentially diminishes the diversification efficacy of a portfolio of keiretsu firms. In summary, our results suggest that the practice of profit and risk sharing, which on the surface seems to be a blessing, may actually have a detrimental effect on the value of keiretsu firms." Copyright (c) 2010 Financial Management Association International.
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