We examine whether the dynamics of the implied volatility surface of individual equity options contains exploitable predictability patterns. Predictability in implied volatilities is expected due to the learning behavior of agents in option markets. In particular, we explore the possibility that the dynamics of the implied volatility surface of individual stocks may be associated with movements in the volatility surface of S&P 500 index options. We present evidence of strong predictable features in the cross-section of equity options and of dynamic linkages between the volatility surfaces of equity and S&P 500 index options. Moreover, time-variation in stock option volatility surfaces is best predicted by incorporating information from the dynamics in the surface of S&P 500 options. We analyze the economic value of such dynamic patterns using strategies that trade straddle and delta-hedged portfolios, and find that before transaction costs such strategies produce abnormal risk-adjusted returns.

We examine the unexplored effects on art markets of artist death (asset supply constraints), collectors' wealth (background risk) and forgery risk (risk of investment fraud), under short-sale constraints and risk aversion. Speculative bubbles emerge and have the form of an option strangle (a put option and a call option), in which strike prices are affected by art supply constraints and the association of the artworks' emotional value with both collectors' wealth and forgery, while the options' underlying asset is the stochastic heterogeneous beliefs of agents. We show that speculative bubbles increase with four elements: art supply constraints; a more negative correlation between collectors' wealth and the artworks' emotional value; a more positive relationship between forgery and the artworks' emotional value; and more heterogeneous beliefs. These four sources of speculation increase the expected turnover rate; however, they also augment the variance of speculative bubbles, which generates price discounts (i.e. risk premiums) for holding artworks. Consequently, the net impact of speculation is not necessarily increased art prices. This study not only contributes to the art market literature, but also to studies about speculative bubbles in other financial markets under heterogeneous beliefs, short-sale constraints and risk-averse investors, since we additionally consider the simultaneous effect of asset supply constraints, investors' background risk and the risk of investment fraud.

We investigate the previously unexplored herding behaviour of investors in option markets, by examining equity option contracts traded in the US between 1996 and 2012. We document strong herding effects in option trading activity that are conditional on a set of systematic factors related to periods of market stress. More specifically, we find that option investors tend to herd during periods of high market volatility risk, on dates of macroeconomic announcements, during the financial crisis of 2008, when a large number of market option positions is either opened or closed, and during periods of a large average dispersion of analysts’ forecasts.

By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare differs with asset volatility: When volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and toward intermediaries. We empirically corroborate our model’s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.