One Security, Four Markets : Canada-US Cross-Listed Options and Underlying Equities

In this paper we examine the relative contributions of US and Canadian markets to price discovery for Canadian cross-listed options and their cross-listed underlying stocks. We use two different econometric approaches in assessing the contributions of each market to price discovery, the information shares approach and the common factor approach. Our empirical results are consistent in both approaches. We show that on average price discovery for cross-listed Canadian stocks and options takes place overwhelmingly in the underlying asset markets, where Canadian equity markets dominate the discovery process. The results show that option markets information shares remain comparable, although slightly higher in the US, which contrasts with the fact that its relative volume is almost ten times greater than that of Canadian options markets. The results also indicate a high degree of integration between Canadian and US markets for the underlying stocks of cross-listed options and show that the foreign exchange market does not contribute to the co integration between these markets to any significant extent. An analysis of the determinants of the relative information shares between firms with all markets analyzed simultaneously shows that the most important factor explaining the information shares is the volatility of underlying returns