Is the synthetic stock price really lower than actual price?

• Main Author: HU, Jianfeng
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2020
• Subjects: arbitrage; law of one price; options; put-call parity; short selling; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/6590; https://ink.library.smu.edu.sg/context/lkcsb_research/article/7589/viewcontent/pd_jfm.pdf
• Institution: Singapore Management University

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.