INTRODUCTIONThis paper analyses UK evidence on the impact of option listing on the returns' process of underlying stocks. In particular, it examines the existence of 'abnormal returns', and the effect of option listing on the systematic risk, unsystematic risk, total risk, skewness and kurtosis of the returns' distribution, as well as the effect on the efficiency of adjustment of prices to new information.We find that option listing is associated with a temporary price increase immediately prior to listing, as against the permanent price increase observed in US markets. Consistent with earlier US based studies, we also find lower unsystematic risk and lower total risk in post-listing daily returns and no change in average beta. The decline in unsystematic and total risk is largely confined to stocks with high pre-listing volatility. Using a simple model for price behaviour allowing for market structure and information related noise, as well as imperfect price adjustment to value changes, we find that there is an increase in the efficiency with which prices adjust to new information. A significant decline is also observed in skewness of returns and this is consistent with the hypothesis that the introduction of put options increases the speed with which negative information is incorporated into prices. Overall, the results suggest that the options market is making a significant contribution to the efficiency of financial markets by reducing risk and improving the adjustment of prices to new information.This paper is organised as follows: the next section provides the background and motivation for the research; the third section describes the methodology and documents the empirical results; and the final section presents the conclusions. BACKGROUND AND MOTIVATION

This paper presents empirical evidence on the effectiveness of eight different parametric ARCH models in describing daily stock returns. Twenty‐seven years of UK daily data on a broad‐based value weighted stock index are investigated for the period 1971–97. Several interesting results are documented. Overall, the results strongly demonstrate the utility of parametric ARCH models in describing time‐varying volatility in this market. The parameters proxying for asymmetry in models that recognize the asymmetric behaviour of volatility are highly significant in each and every case. However, the ‘performance’ of the various parameterizations is often fairly similar with the exception of the multiplicative GARCH model that performs qualitatively differently on several dimensions of performance. The outperformance of any model(s) is not consistent across different sub‐periods of the sample, suggesting that the optimal choice of a model is period‐specific. The outperformance is also not consistent as we change from in‐sample inferences to out‐of‐sample inferences within the same period. Copyright © 2000 John Wiley & Sons, Ltd.