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Box Spread Arbitrage Profits following the 1987 Market Crash: Real or Illusory?

Published online by Cambridge University Press:  06 April 2009

Michael L. Hemler  and
Thomas W. Miller Jr
Michael L. Hemler
Affiliation:
College of Business Administration, University of Notre Dame, Notre Dame, IN 46556
Thomas W. Miller Jr
Affiliation:
College of Business and Public Administration, University of Missouri, Columbia, MO 65211
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Abstract

We examine market efficiency before and after the 1987 Market Crash using the box spread strategy implemented with European-style S&P 500 Index (SPX) options. Before the Crash, apparent arbitrage opportunities were rare and simulated trades were unprofitable assuming a one-minute execution delay. After the Crash, apparent arbitrage opportunities were frequent and simulated trades were profitable even assuming a five-minute execution delay. Our analysis makes the routine assumption that quotes are good until updated to construct a time series of prevailing quotes sampled at 30-second intervals. If this assumption is valid, then arbitrage profits were actually available. If this assumption is invalid, then such profits could have been illusory. Either scenario, however, implies that SPX market efficiency decreased following the Crash—prevailing price quotes repeatedly failed to satisfy the fundamental parity relation underlying the box spread.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 32 , Issue 1 , March 1997 , pp. 71 - 90
Copyright
Copyright © School of Business Administration, University of Washington 1997

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