Abstract

In response to the need for a simple financial instrument that enables retail investors to easily and quickly participate in the U.S. equity market and for a vehicle that facilitates basket trading by institutions, the American Stock Exchange introduced Standard and Poor's Depository Receipts (SPDRs) on January 29, 1993. The purpose of this study is to determine the effects of the introduction of SPDRs on the pricing efficiency of S&P 500 futures market and S&P 500 options market. Using a measure of efficiency that is based on the signed difference between the observed futures price and the theoretical futures price as per the Cost of Carry model, we find that the positive mispricing is reduced when SPDRs are introduced. When the absolute values of the differences are used as the measure of efficiency, the results also show an improvement in the pricing efficiency of the futures markets. Using an ARIMA(4,0,4)-TGARCH(1,1) model, rather than the OLS model, provides us with a more precise test of the mispricing series and supports the findings above. Tests of pricing efficiency of the index options market are conducted by measuring the frequency and magnitude of violations of the no-arbitrage conditions as per the Put-Call Parity. Results from the index options market indicate that arbitrage opportunities do exist but no clear cut conclusion could be made regarding the effect of SPDRs on the index options market. When taking transaction costs into consideration, it is clear that both the frequency and the magnitude of arbitrage opportunities are reduced