Econometric modeling for transaction cost-adjusted put-call parity: evidence from the currency options market

Abstract

Due to the mispricing of options, no-arbitrage condition put-call parity (PCP) violations lead to inefficiency in the currency options market. Through transaction costs, the effects of these violations are reduced to negligible levels, indicating that PCP is not a sufficient condition for an options market efficiency test. Thus, this study developed a transaction cost-adjusted put-call parity (TC-Adj-PCP) econometric model to examine the efficiency of options markets. The fundamental analysis of the proposed model concludes that transaction costs represent an omitted variable for the PCP model, where the uniqueness of this variable is demonstrated under PCP in the context of options market efficiency. The novelty of the TC-Adj-PCP model resolves controversial transaction costs issues for traders and researchers.