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This paper presents empirical evidence that trading in options contributes to both transactional and informational efficiency of the stock market by reducing the effect of constraints on short sales. The significantly higher average level of short interest exhibited by optionable stocks supports the argument that options facilitate short selling. We also find significant effects on option prices, related to the short interest in the underlying stock. We then present evidence that options also increase information efficiency. Earlier work, that is replicated and extended here, has suggested that short sale constraints cause stock prices to underweight negative information. Options appear to reduce that effect.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. The MIT Press is collaborating with JSTOR to digitize, preserve and extend access to The Review of Economics and Statistics.Abstract-Standard approaches to designing a futures hedge often suffer from two major problems. First, they focus only on minimizing risk, so no account is taken of the impact on expected return. Second, in estimating the hedge ratio, no allowance is made for time variation in the distribution of cash and futures price changes. This paper describes a technique for estimating the optimal futures hedge that corrects these problems, and illustrates its use in hedging Treasury bonds with T-bond futures.

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