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Is the synthetic stock price really lower than actual price?
Author(s) -
Hu Jianfeng
Publication year - 2020
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.22153
Subject(s) - arbitrage , leverage (statistics) , monetary economics , stock (firearms) , voting , economics , short interest ratio , business , stock price , financial economics , computer science , mechanical engineering , paleontology , context (archaeology) , machine learning , series (stratigraphy) , politics , law , political science , engineering , biology
Conventional wisdom suggests synthetic stock prices are lower than actual prices due to short‐sale constraints and voting premiums. This study finds that such underpricing of the synthetic midquote disappears if arbitrageurs face security borrowing costs. The synthetic spread predominantly contains the actual spread. Synthetic stock overpricing is as common as underpricing but the former is more persistent and more profitable. The difference between synthetic and actual quotes is significantly affected by options market makers' hedging costs and investors' demand for leverage.