Review of Quantitative Finance and Accounting, 17: 267–282, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
Option Trading and the Intervalling Effect Bias in Beta
LI-CHIN JENNIFER HO
AND JEFFREY J. TSAY
University of Texas at Arlington
Abstract. Prior studies show that the beta coefﬁcient of a security changes systematically as the length of
measurement interval is varied. This phenomenon, which is called the intervalling effect bias in beta, has been
attributed to the friction in the trading system that causes the delays in the price-adjustment process. This study
shows that option listing is associated with a decline in the beta intervalling effect bias. The decline is most
pronounced for small ﬁrms. We also ﬁnd that our sample ﬁrms grow signiﬁcantly after option listing. Since prior
research indicates that market value is a major determinant of the magnitude of the intervalling effect, we re-
examine our results using a subsample that controls for market value. The results indicate that the decline in the
beta bias from the pre-listing to post-listing period is still prevalent after we control for the change in ﬁrm size.
Overall, the evidence is consistent with the notion that option trading reduces the delays in the price-adjustment
process, which in turn reduces the intervalling effect bias in beta.
Key words: option trading, beta estimation, intervalling effect bias
JEL Classiﬁcation: G10
This paper examines the impact of option trading on the intervalling effect bias in beta.
Theoretically, the systematic risk or beta coefﬁcient of a security should be invariant with
respect to the length of the differencing interval used to measure the returns. However, much
empirical evidence shows that the observed beta coefﬁcient changes systematically as the
length of the measurement interval is varied (see, e.g., Pogue and Solnik, 1974; Cohen et al.,
1983a, 1983b; Corhay, 1992). This phenomenon, which is called the intervalling effect bias
in observed betas, has been attributed to the friction in the trading process that delays the
price adjustment to new information ﬂowing into the market (Cohen et al., 1983a).
Prior research also suggests that option listing and subsequent trading reduces the friction
in the price-adjustment process and thereby enhances market efﬁciency. The presence of
options increases investors’ trading opportunities by circumventing short-sale restrictions
(Cox and Rubinstein, 1985), reducing margin requirements (Black, 1975), and providing
additional risk-return tradeoffs (Ross, 1976; Breeden and Litzenberger, 1978). Option mar-
kets also attract additional traders who have different information (Black, 1975; Grossman,
1989) and accelerate the rate at which private information is revealed in observed trading
Address correspondence to: Li-Chin Jennifer Ho, P.O. Box 19468, College of Business, University of Texas at
Arlington, Arlington, Texas 76019-0468, Fax: 817-272-5793. E-mail: email@example.com