American Finance Association

Stock Splits, Volatility Increases, and Implied Volatilities Author(s): Aamir M. Sheikh Source: The Journal of Finance, Vol. 44, No. 5 (Dec., 1989), pp. 1361-1372 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2328647 . Accessed: 26/10/2011 02:31
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

Blackwell Publishing and American Finance Association are collaborating with JSTOR to digitize, preserve and extend access to The Journal of Finance.

http://www.jstor.org

THE JOURNAL OF FINANCE . VOL. XLIV, NO. 5 . DECEMBER

1989

Stock Splits, Volatility Increases, and Implied Volatilities

AAMIR M. SHEIKH* ABSTRACT to relative post-split Exchange, BoardOptions of A testoftheefficiency theChicago and The is stocks, presented. Black-Scholes Roll of in increases thevolatility common deviations of standard the formulas usedtoexamine behavior implied are pricing option of group with Comparisons a control and splitannouncement ex-dates. (ISDs) around a However, relative splits. announcing in increase ISDs ofstocks stocks find relative no that the Therefore, jointhypothesis 1) theBlackat is increase detected theex-date. can are Scholes and Rollformulas trueand 2) theCBOE is efficient be rejected.

variin increases the observed significant and French(1985) have documented than 25%. This is to subsequent splitslarger stockreturns ance of common withthe actualday of no because,in theory, realeventis associated surprising to thesplit.Dravid(1988) and Lim and Vijh (1986) havetried explainthepostand of as increase the effect stockpricediscreteness thebid-ask splitvariance in spread.'The evidence Lim and Vijh (1986) and Ohlsonand Penman(1985) explanation.2 that however, thisis at besta partial suggests, the are increase notapparent, post-split the Although causes ofthevolatility stock)that increaseshouldincreasepricesof calls (on the splitting volatility the before ex-date. Similarly, to relative thosethatexpire the after ex-date expire to relative shouldincrease stocks calls on splitting expiration of prices post-split these market, options pricesofcalls on stocksthatdo not split.In an efficient of relative pricechangesshouldoccurat the announcement the split.In fact, of splits announcing thatprices calls on stocks and Gustavson (1985) find Reilly of group stocks. relative pricesofcalls on a control to do increase is A problem withtestsbased on call priceincreases thattheymaybe due to
* Finance Department,School ofBusiness, Indiana University. part of myPh.D. This paper forms dissertationwrittenat the Universityof California,Berkeley.An earlier version of this paper was presentedat the 1986 AFA meetings.I would like to thank Greg Connor, Roy Henriksson,James Hoag, Tee Lim, Michael Parkinson, Bruce Resnick, Ehud Ronn, Mark Rubinstein,Anand Vijh, the and advice. Research supportfrom University for comments Gautam Vora,and the referees helpful acknowledged. of Californiaand the BerkeleyProgramin Finance is gratefully 1 Dravid (1984, 1988), e.g., has shown that estimatedreturnvariances are biased upward due to the bid-ask spread and roundingof stockprices to the nearest$0.125. 2 For example,the median post-splitserial covariance of returns was positiveforthe Ohlson and Penman sample, whereas significantdiscretenessand bid-ask effectswould make this covariance negative.

RECENTSTUDIES BY OHLSON and Penman (1985), Dravid (1984), and Dubofsky

1361

1362

The JournalofFinance

Moreover, values call splits.3 announcing in increases the sharepricesof firms of prices thatcovers and in areincreasing thetimeto maturity, anystudy option the around relevant study) in of period time(onemonth thepresent a reasonable a movein the values of calls as timeprogresses. dateswillcapture downward a from can stockvolatility be drawn aboutanticipated Thus,no clearinference and splitannouncement exaround of examination call pricemovements simple dates. of and In thispaper,I examinethe announcement ex-datebehavior return priceand maturity for controlling stock thereby by volatilities implied callprices, formulas pricing (1973) and Roll (1977) call option The Black-Scholes changes. An (ISDs) of stockreturns.4 deviations standard are used to solveforimplied in the surrounding splitannouncement, the overthemonth on increase, average, date mayindicate the after ex-split maturing of volatilities call options implied increasein stock the anticipates post-split properly that the optionsmarket return volatility. to related option to have however, beenfound be negatively volatilities, Implied of stocksalso move volatilities different maturities (1985)). Implied (Rubinstein around ISDs mayincrease and (Schmalensee Trippi(1978)).Therefore, together of maturities theunderlying simply becauseof decreasing splitannouncements The question, volatilities. relevant changesin anticipated calls or market-wide a thatannounce splitincrease in is ISDs ofstocks addressed thisstudy, whether is at stocks.5 suchincrease detected the announceNo relative ISDs ofother to however, at ex-date, increaseis detected the predictable mentdate. A relative market. in for and translates excessreturns market-makerstheoptions into in is the as The restofthepaperis organized follows: methodology discussed and ofthetests, SectionIII summarizes the I. Section SectionII contains results and concludes paper. the I. Methodology
A. Data

December stocksthatsplitbetween The study includes CBOE optionable all than0.25,and did not larger 1, 1976and December 1983,had splitfactors 31, in following suchas mergers, theninemonths changes, undergo majorstructural of thesplit.This leadsto a sampleof83 stocksplits, which30 had splitfactors and announcement exof smaller length timebetween thanone. The smallest from wereidentified theCRSP 165 the dateswas 34 days, largest days.The splits withCBOE options. a Masterfileand checked against listofstocks Monthly
'These increases have been observed at both the announcement and ex-dates by Grinblatt, Masulis, and Titman (1984) and Dravid (1984). of of volatility 4Past work,e.g., Beckers (1981), has foundISDs to be betterpredictors the future suggests stock returnsthan volatilitiesestimated fromthe past time series of returnsand strongly of volatility a stock's returns. the that ISDs do reflect expectedfuture 'After this researchwas completed,a paper on the same issue by French and Dubofsky(1986) from theirsbecause I account differs significantly was brought myattention.My research,however, to screenthe forthe effect earlyexerciseby using the Roll model,employtransactionsdata, carefully of marketprices,and use a controlgroupto abstractfrom data to exclude recordsthat do not represent changes in anticipatedvolatilities. and maturity-related market-wide

StockSplits, Volatility Increases,and Implied Volatilities

1363

The Ohlson and Penmantest was repeatedon this sample:the post-split thanthe to was dailyreturns found be larger from estimated deviation standard in deviation 55 out of83 cases,withan associated standard estimated pre-split The median at positive the 1% level.6 of z-statistic 2.85,whichis significantly withthe was deviations 20.6%. Thus, consistent standard changein estimated ex-date a the of findings Ohlsonand Penman, splitsampleexhibits significant variances. in increase return the It is important identify earliestdate at whichthe CBOE may have to for Indexwasscanned sixmonths Journal The WallStreet known aboutthesplit. thatdiscussed for date prior thesplitannouncement ontheCRSP files articles to to splitswerefound havebeen the a possiblesplitbefore CRSP date.Eighteen the day the before date givenby CRSP. For these,thetrading before proposed date. Journal article takenas theannouncement was dateofthe WallStreet volbiases in ISDs and market-wide changesin anticipated Maturity-related each splitwitha stockthatdidnotsplitor by atilities werecontrolled matching of the a announce splitin theperiod15 daysbefore announcement the splitto betasandmonthly had The and match comparable 15daysafter ex-date. split the the split. Betas and varianceswere variancesin the year preceding return on stockreturns of available)60 monthly estimated an OLS regression (when by the index.Whenpossible, stockswere thereturns the CRSP valueweighted to The return data and the of SIC codes.7 two also matched thefirst digits their on and Returns Masterfiles. the from CRSP Monthly SIC codeswereobtained surrounding for wereobtained one month data on call options Transactions the from ConsolThe and thesplitannouncement ex-dates.8 data wereretrieved OptionsData base. These tapes containa idatedData Tapes of the Berkeley of summary all available trades and quotes on the Chicago Board Options August23, 1976 to December31, 1983. Duringeach Exchange(CBOE) from for all stockis nottraded, records a givenoption whentheunderlying interval the prices containing highand low option into are consolidated a singlerecord the volumesat the highand the low,the total the during interval, contract the consolidated, number the of volume, number rawtradeand bid-askrecords thelasttradepricefor of five ofbid-ask quotesin thefirst minutes theinterval, stock and prices. thestock, information and aboutpreceding following in to sevencriteria be included An optionrecord thefollowing had to satisfy thestudy: date; after ex-split the matured 1) theoption had at least21 daysto maturity; 2) theoption
the split were 'Daily returnsfor 30 tradingdays beforethe split and 31 tradingdays following obtainedfrom the CRSP Daily Returns file. within20% ofthe split's standard returns 7 The matchhad to have a standarddeviationof monthly two digitSIC code and deviationof monthly returns. Withinthis class, the matchwiththe same first beta of the match was not closest beta was selected forthe controlgroup.However,if the resulting within20% of the beta of the split, the matchingon the basis of SIC codes was dropped,and the match with the closest beta, within a 20% standard deviation range, was selected for the control group. 8 Given the large numberof data tapes to be searched, a period of one month was chosen as a compromisebetween a reasonable period for allowing the CBOE to react to the split and cost considerations.

1364 3) 0.85E c P
<

The JournalofFinance

4) 5) 6) 7)

priceofthecall; therecord notoccurin the first did 1000secondsafter 9:00 A.M. or in the last 1000seconds before 3:00 P.M.; thehighand lowoption pricesdidnotdiffer more by than$0.25; at leastthree contracts were traded during constant the stock priceinterval; and at leastthree rawrecords wereconsolidated.

1.15E, where P denotes the stock price and E the exercise

The first condition necessary the purposeof the studyand needs no is for discussion. The secondcriterion eliminates veryshortmaturity calls, and the third or These eliminates thataredeepin themoney deepoutofthemoney. calls calls are excluded are sensitive to because theirimplied volatilities extremely four smallchangesin the call price.9 The remaining criteria to ensurethat are weuse records reflect The criterion eliminates trades that market prices.10 fourth thatmayhavebeen heldoverfrom previous and market-maker the day quotes The at the end ofthe dayto influence theirmargin requirements. tight option priceinterval desirable as to obtaina relatively is so accurate option price.The lasttwocriteria ensure thattheoption traded somedepth. is in These sampling the in records themonth in around restrictions resulted a totalof20,206option splitannouncement 28,329observations and around ex-split the date. The interest usedwastheyield maturity a Treasury with rate to of bill maturity wereobtained from closest thematurity theoption. to of Treasury yields bill the CRSP Fama TermStructure files.Since thesedata are recorded a monthly on was the rates basis, a simpleconvexcombination used to interpolate interest between record the dates.11 Dividenddata were collectedfromthe CRSP MonthlyMaster file. Past in or researchers of have used actualdividends the computation Black-Scholes of Rollvaluesorto obtain ISDs. This study usesthemarket's expectations future dividends. seldomchangetheirdividends Since moststocksthatpay dividends and tendto pay dividends the sametime(usually same dayoftheweek) at the that the market uses the last quarterly every year,it is reasonable (monthly, whena normal semi-annual, annual)dividend quarterly (monthly, dividend etc.) is expected. if is but not announced, last the Therefore, a dividend expected similar is announced dividend used.Whena stockfollows predictable a pattern withextraor special dividends, dividends. Other these are treated regular as extradividends considered are onlyas they announced.12 are The Roll (1977) formula strictly appliesonlyto calls witha singledividend
9See Schmalensee and Trippi (1978) and Beckers (1981). Butler and Schachter (1984) point out that ISDs are biased estimatesofthe truestandarddeviationof stock returns due to the nonlinearity of the Black-Scholes formulain this standard deviation. Nevertheless,their simulationsalso show that averagingthe ISDs fromseveral close-to-the-money calls tends to cancel out the biases in individualISDs. These are derivedfromRubinstein(1985). l This should not affectthe results significantly because the pricingformulasare insensitiveto the interestrate. 12 The effect the dividendadjustment of was checkedby repeatingpart of the analysis withactual dividends.The resultsdid not change significantly.

StockSplits, Volatility Increases,and Implied Volatilities

1365

haveresulted would to attention suchcalls,however, Restricting before maturity. before calls withmorethan one dividend in a verysmall sample.Therefore, onlyat was but in were maturity included the sample, earlyexercise considered on effect ISDs This has a negligible maturity. date the last ex-dividend before the before lastex-dividend that unlikely a call willbe exercised becauseit is very maturity.13 datebefore usingnumerical wereobtained of deviations dailyreturns Impliedstandard $0.01 ofthe market call untilthe resulting value was within searchprocedures averageof as The market priceof the call was computed the weighted price.'4 If as volumes weights. boththese usingcontract the highand low call prices, was of average thehighand lowprices arithmetic werezero, simple the volumes to used.The ISDs wererestricted the range[0.001,0.1] becausethesewerefelt Twenty to be reasonablelimitsfor daily stock returnstandarddeviations. aroundthe announceof four the 20,206optionrecords thousand, hundred one ment,and 28,149of the 28,329recordsaroundthe ex-date,had convergent solutions.
B. Tests

three to Because the resultsmaybe sensitive the way ISDs are aggregated, and of measures usedto testtheeffect thesplitannouncement exare different The volatility. first, uses the samplemeanofthe ISDs dateson anticipated a,, the and after of each stockto obtaina singleISD forthat stockbothbefore the in from IBM options thetwoweeksbefore event; e.g.,all theISDs obtained ISD intoa single pre-announcement forIBM, are splitannouncement averaged are the IBM in thetwoweeksafter announcement averaged and all theISDs for in ISD intoa single post-announcement forIBM. Percentchanges a1 are then signedfor and sign obtained eachstock, thepaired-sample testandtheWilcoxon The changesacrossthesampleofstocks. ranktestare appliedto thesepercent alternative of nullhypothesis no changein ISDs is testedagainsttheone-sided row to referring thefirst ofTable I, outof in ofan increase ISDs. For example, were62 forwhichat least one optionrecord there splits, 83 stocksannouncing as before announcement wellas the the in passedthedata screens thetwoweeks of the the allowing computation a1 bothbefore twoweeksafter announcement, 39 changes Of percent and after announcement. the 62 stocks, had positive the sign paired-sample test in a1,witha medianchangeof2.76% and an associated staisicof(39-0.5) - 62/2
statisticof ( 6)-/4 2 test statisticof = 1.91 and a Wilcoxon signed-rank

are positive. 2.4,bothofwhich significantly sample the 02, The secondmeasure, uses,foreach stock, pre-and post-event
and an annual 13 Calculations assuming dividendsfour months and one month beforematurity interestrate of 10% show that a dividendyield in excess of 6.7% is requiredforearly exercise of a call deep-in-the-money at the firstdividenddate. This is largerthan the dividendyield on all of the dividendsit is extremely unlikely 30 stocksin the Dow JonesIndustrialAverage.Thus, withquarterly that a call will be exercisedearlyexcept at the last ex-dividenddate beforematurity. " An IMSL routine,MDB3NOR, was used to computethe cumulativebivariatenormaldensityfor the Roll formula.

1366

The JournalofFinance
Table I

The changes are for83 stocks that split betweenDecember 1, 1976 and December 31, 1983, and for a control group of stocks. The control group is formedby matchingeach splittingstock with a The Roll (1977) formulais used stock of similarbeta and standarddeviationof returns. nonsplitting to computeISDs. a, is the sample mean of the ISDs fromall call recordson a given stock. (2 is the sample mean of the ISDs fromcall recordswith0.95E c P s 1.05E and r > 70, whereE denotes the exerciseprice,r the numberof days to expirationof the call, and P the stock price. c73 iS obtainedby where i indexes stocks,j indexes estimatesof ISDij = ai + OiRij, settingRij = 1 in the OLS regression call records on the stock, and Rij is the ratio of the stock price net of escrowed dividends to the presentvalue of the exerciseprice of the call. For a givenstock,each measure is obtainedbeforeand afterthe announcementand the percent change in the measure is computed. Under Splits and Controls:N is the numberof stocks forwhich therewere enough call recordsto allow computation N+ is the numberof stocks forwhich ofthe givenmeasure,both beforeand afterthe announcement. with ISD measure.Correlation ISD measureexceeded the pre-announcement the post-announcement betweenthe percentchanges in the given Actual Ex-Date Changes is the Spearman rank correlation ISD measure and ex-date changes in standard deviations estimated from daily returns.Under Between ...: N is the numberof observationswhere therewere enough call recordsfor Difference both a split and its control to allow computationof the given ISD measure before and afterthe N+ is the numberof observationswherethe percentchange in a split's ISD exceeded announcement. the percentchange in the ISD of its control. Difference Between the Percent Change Splits Controls in the ISD of a Percent Change in the ISD of Its Control Aggregate ISD Measure N
U2 c3

Changes in Implied Standard Deviations (ISDs) of Stock Returns Around Stock Split Announcements

N+ 39 30 34

Median % Change
2.76ab 2.76b

Correlationwith Actual Ex-Date N Changes -0.06 -0.03 -0.05 58 46 53

N+ 37 25 28

Median % Change N
2.36a,b

N+ 24 14 21

Median -0.05 -1.71 -0.57

62 52 59

2.18

0.98 1.48

49 29 43

we test,respectively, can reject, Using the paired-samplesigntest and the Wilcoxon signed-rank at the 5% level, the null hypothesisof 1) no change in the given ISD measure against the one-sided comparisons and 2) no difference alternativeof a positive percent change, for the within-group between splits and controls in percent changes in the given ISD measure against the one-sided for comparisons. alternativeof a positivedifference, the between-group
a,b

and a than70 daysto maturity with ratio with more meansofISDs from options 0.95 and value of the exercise pricebetween of the stockpriceto the present calls. very to 1.05,i.e., middle longmaturity, near-the-money These restricted of for samplemeansare testedin thesamewayas a1. The number observations on screens the stricter sampling thanthatforx-becauseO-2imposes 02 is smaller data.'5 options all For each period, third method regresses ISDs of a givenstockon the the value of the to dividends) the present ratioof the stockprice(net of escrowed
15

Tests based on sample medians,foro-Iand 02, yield similarresults.

and Volatilities Increases, Implied Splits, Volatility Stock

1367

are the priceused in computing ISDs. The resulting estimates used,for exercise an option, i.e., ISD to each stock, obtaina pre-and post-event for at-the-money denoted is subjected This lastmeasure, the which aboveratiois unity. one for a3, of than for and 02.The number observations 03 is smaller to thesametestsas aofor at records each stockto pass thatfor0i because073 requires leasttwooption only whilea, requires event, the bothbefore after relevant and thedata screens, for each stockin each ofthetwoperiods. one option record group increase the whether ISDs ofthe splitor control to In addition testing change an ISD measure in the I event, testwhether percent around relevant the thanthepercent a stockis larger changein thesame (01r 02, or C3)for splitting of for The number observations the between-group measureforits control. becausethe comparisons is thanthatforthewithin-group comparisons smaller optionrecordsto pass the data requireenough comparisons between-group whilethe to a screens compute changein ISDs forboththe splitand control, for requireonly enoughobservations each group comparisons within-group separately. II. Results of A. The Behavior ImpliedVolatilities is of The behavior ISDs aroundsplitannouncements givenin Table I. Both in witha, providing variances, thesplits andthecontrols showincreases implied the show,howbetween twogroups Comparisons themostsignificant increase. from in different thatthepercent changes splitISDs are not significantly ever, of controls. as column in Further, thefifth thepercent changes theISDs oftheir Spearman rank insignificant low thetableshows, thereis very and statistically in changes ISDs ofsplitting date the between announcement percent correlation estimated deviations changesin theirstandard stocksand the ex-datepercent in date data. The announcement increase ISDs thusseemsto from stockreturn One of variance increase. thananticipation a post-split other be due to factors and maturity implicit relationship between lies explanation in a negative possible (1985). by as options Rubinstein out-of-the-money variances, notedfor in The behavior ISDs around is splitex-dates given Table II. Allofthethree of In the for increase significantly the splitgroup. contrast, control ISD measures decreasein ISDs for insignificant exhibits, the mostpart,a statistically group betweenthe two groupsshow that the the split period.Comparisons during in thanthepercent changes theISDs of in changes splitISDs are larger percent the between exis correlation positive Table II showsthatthere a significantly and theex-date stocks changes percent datepercent in changes ISDs ofsplitting from Thus,theCBOE picks in their dailyreturns. estimated deviations standard as variance increase it occurs.'7 up theex-date
16 in be of statistical for insignificancetheresults a3may dueto nonlinearities therelationship in and are model in employed this between by depth themoney ISDs which notcaptured thelinear paper. 17 Interesting over entire the of were uncovered a closer period. details examination ISD changes by

so theircontrols,and significantly for 0i and

(2.16

column of Further,the fifth

1368

of TheJournal Finance
Table TI

31, December 1976and December 1983,and for 1, thatsplitbetween are 83 The changes for stocks stockwitha each splitting by groupis formed matching a control groupof stocks.The control is The deviation returns. Roll(1977)formula used of betaand standard nonsplitting ofsimilar stock stock. is the U2 on all meanoftheISDs from call records a given to compute ISDs. a, is thesample E the with 0.95E ' Ps 1.05Eand X > 70,where denotes call meanoftheISDs from records sample r of by price. is obtained exercise of price, thenumber daysto expiration thecall,andP thestock a, stocks, indexes where indexes i estimates ISDij = a, + fliRij, of setting = 1 in theOLS regression R-j to dividends the on and Ri,is the ratioof the stockpricenet of escrowed call records the stock, before and is stock, eachmeasure obtained valueoftheexercise priceofthecall.Fora given present is and in UnderSplitsand Controls: N change themeasure computed. after ex-date thepercent the call to of there wereenough records allowcomputation thegiven is thenumber stocks which of for of for the ISD and N+ the both measure, before after ex-date. is thenumber stocks which post-split withActualEx-Date Changesis the ISD measure.Correlation exceededthe pre-split measure and ex-date the rankcorrelation between percent changesin the givenISD measure Spearman . Under Between . .: N is the Difference in estimated daily returns. from deviations changes standard to of call for where there wereenough records botha splitand itscontrol allow number observations of and the N+ of ISD measure before after ex-date. is thenumber observations computation thegiven in change theISD ofitscontrol. the where percent the in ISD exceeded percent change a split's Difference Between the Percent Change Splits Controls Splitand the Percent Change in theISD ofIts Control

Changes in Implied Standard Deviations (ISDs) of Stock Returns Around Stock Split Ex-Dates

Median% Aggregate ISD Measure N N+ Change

?w1
?72
073

with Correlation Median% Actual Ex-Date N N+ Change N N+ Median Changes

0.48c 63 22

51 35
40
48

5.73a,b

28
27

6.33ab
3.97b

0.34c
0.41c

43
58

22
25

-3.59a -2.16

46 41

32

7.59a,b

0.014

24

15
23

6.50b 4.17

we test, signed-rank respectively, can reject, sign Using paired-sample testandtheWilcoxon the ISD measure the in of against one-sided at the5% level, nullhypothesis 1) no change thegiven the and for of comparisons 2) no difference alternative a positive change, the within-group percent in between againstthe one-sided changesin the givenISD measure splitsand controls percent of for alternative a positive comparisons. difference, thebetween-group the different zero-at 5% level. from c Significantly
a,b

in in increases a, between splitsand controls percent The mediandifference is is 7.59% in the montharoundthe split.This difference less than halfthe from and in deviations estimated dailyreturns 20.6% median increase standard of is closerto the Ohlsonand Penmanfinding an 11% increasein estimated
the stocks found is between announcement and increase ISDs ofsplitting in No absolute relative or the in and relative increase theex-date. significant A absolute daysaround exoccurs just fifteen correlation theincreases standard with in deviations has and positive date, thisincrease a significant continue increase to relative the to ISDs ofsplitting stocks estimated from Moreover, dailyreturns. the the control day beyond seventh after split. group

Increases,and Implied Volatilities StockSplits, Volatility

1369

thatpart,butnotall, of This indicates returns. of deviations monthly standard standard deviations dailyreturns of maybe the ex-dateincreasein estimated of such as the bid-askspreadand rounding stock effects, due to measurement of the with findings Lim and Vijh $0.125,and is consistent to prices thenearest (1986)and Dravid(1988).
B. EconomicSignificance

thatthe CBOE did notreactto thepostis: The nextnatural question given profits economic werethere ex-date, untilthepredictable increase splitvariance stocks, in of from notedincrease theprices splitting the to be made?To abstract index: in I study percent changes thevalueofthefollowing
BS = N
-

N[a1].

at-the-money valueofa six-month, the This is simply ratiooftheBlack-Scholes The value of this indexis seen to stock.'8 call to the priceof the underlying and changesin BS are dependonlyon the varianceof stockreturns, percent stockprice and to accruing call optionsaside from indicative the returns of bothbefore and after for The indexis computed each stock, maturity changes. usingal, a2, and 03. theex-date, this from indexaroundexthe Panel A ofTable III contains medianreturns to medianreturn the splitsampleexceedsthatof the control splitdates.The in withthe difference median measures, volatility for group all threeexpected 6.08%for03 to 9.28% fora1. ranging from at one (over, most, month) returns to theseexcess Transaction however, allowonlymarket-makerscapture costs, for costsare obtained an of inclusive transaction For returns returns. each split, before after and call. six-month The valueofthiscall is obtained at-the-money, values median stock priceand pre-and post-split theex-date usingthepre-split costs are then added to the value of this call when it is of a1. Transaction the whenit is sold after split.Public the before splitand subtracted purchased are and arbitrageurs assumedto pay a $0.125 bid-askspread,while traders the costsfor to Commission are market-makers assumed earnthesamespread."9 costs from CharlesSchwaband Co.,Inc. Clearing publicarebasedon a schedule and for are assumedto be $1.50 and $0.50 per contract arbitrageurs marketbased on this the Panel makers, respectively.20 B of Table III contains returns
is as depthin the money measured the ratioofthestockpriceto thepresent 1 For the index, price. valueoftheexercise 19 This assumes to activities calls on scalping partoftheir thatmarket-makers able to shift are wantto thatthey to stocks and continue buyat thebid and sell at theask. To theextent splitting and after split, the thismaynotbe possible, before splitand sell orders the ensure their orders buy period given Nevertheless, thelongtime to be returns would similar thoseofarbitrageurs. then their can likely market-makers waittobuyat the that it and split between announcement ex-dates, is very given the could that bidandsellat theask.Thus,itis reasonable market-makers haveearned returns in PanelB ofTable III. 20 Thesecosts (1980)and represent and given Phillips Smith in end areat thelower oftheranges the do the end costs.Nevertheless, from higher oftherange notchange costs discounted transaction results significantly.

1370

TheJournal Finance of
Table III December are callson 83 stocks thatsplitbetween The returns for of group and for callson a control 1, 1976and December 1983, 31, each splitting by groupis formed matching stocks.The control stock of similarbeta and standard stock with a nonsplitting as The value of the index is computed deviationof returns. lV[ >]j [
j, where is one ofthree aggregate ISD ai

Returns to a Call Index Around Ex-Split Dates

ISDs. a, is is The measures. Roll (1977) formula usedto compute all on stock. meanoftheISDs from call records a given thesample with 0.95E c call meanoftheISDs from records a2 is thesample T P c 1.05E and T > 70, where denotes exercise E the price, the of price.03 number daysto expiration thecall,and P thestock of of estimates is obtained setting by Rij- 1 in the OLS regression on call stocks, indexes records where indexes i j ISDij = ai + f3iRij, and Rij is the ratioof the stockpricenet of escrowed the stock, valueoftheexercise priceofthecall. For dividends thepresent to and the is before after ex-date a given eachmeasure obtained stock, N in valueis computed. index andthepercent change theresulting to of optionrecords is the number splitting stockswithenough and after ex-date. the of allowthe computation the indexbefore index returns. stocks with of positive N+ is thenumber splitting for PanelA: MedianGrossReturns, Separately Each Group Controls Splits ISD Measure
al
a2

a3

5.71%a 6.29%a 3.94%

-3.57% 0.01% -2.14%

Returns SplitGroupb for CostsAdjusted PanelB: Transaction Trader Group Public Arbitrageurs Market-Makers N 51 51 51 N+ 12 29 42 Median% Return -10.6a 1.8 8.7a

zero at the 5% level,usingthe different from aSignificantly test. signed-rank Wilcoxon bTransaction costs are based on the dollarvalue of one call the this contract. eachsplit, callvalueis computed For using median the stockpricein the 15 daysbefore splitand thepre-and postvalueofa1. split

for negative are costsadjustedreturns significantly The procedure. transaction and from different zeroforarbitrageurs, thepublic, closeto and insignificantly to return marketThe for and positive market-makers. median high significantly returns. Sincethesereturns makers 8.7%,with of51 splits is 42 positive providing effects and variance stock the price from stock abstract pricemovements, positive investment attractive stocks unusually an makecallson splitting should together for market-makers.2'
21Actual an call returns from buying at-the-money (0.95E :

the P s 1.05E)in the14 daysbefore

StockSplits, Volatility Increases,and Implied Volatilities

1371

ITI. Summaryand Conclusion

The resultsshow that the CBOE did not anticipatepost-splitincreases in stock returnvariances. Although ISDs of splittingstocks increase at both the announcementand the ex-date,the increase at the announcementis not signifithe change in ISDs of the controlgroupand is unrelatedto from cantlydifferent variances. On the otherhand, the ex-dateincrease the ex-dateincrease in return largerthan the change in JSDs of the in ISDs of splitting stocks is significantly correlatedwith the ex-date increase in return controlgroupand is significantly variances.The ex-date increase in ISDs is smallerthan the increase in standard deviationsestimatedfromdaily returns, indicatingthat the post-splitincrease The ex-date in observedreturnvariances is partlydue to measurementeffects. increase in implied variances translates into excess returnsto market-makers from stocks. calls on splitting

was 14.7% splitand holdingit for14 days werecomputedforthe sampledrecords.The medianreturn impliesa decline of 6% in forthe splitsand -8.8% forthe controls.The 14-daydecrease in maturity are to call. The negativereturns the controlgroup,therefore, at-the-money the value of a six-month, changes, the changes. Moreover,given the 6% decline due to maturity drivenlargelyby maturity and stockprice increases is 14.7 + 6 - 20.7% forthe splits.Of this,6.3% (the due to volatility return increases,so that 14.4% is due to stock index returnforcr2in Table III, Panel A) is due to volatility six-monthcall is about 6, so that the 14.4% call price increases.The elasticityof an at-the-money, to corresponds a stock returnof 2.4%, whichis close to the 1.9% returnin the 14 days around return Ma ulis, and Titman (1984). stocksplits foundby Grinblatt, REFERENCES of stock price Beckers,Stan, 1981, Standard deviationsimpliedin optionprices as predictors future variability, JournalofBanking and Finance 5, 363-381. Black, Fischer and MyronScholes, 1973, The pricingof options and corporateliabilities,Journalof PoliticalEconomy81, 637-654. Butler,J. S. and Barry Schachter,1984, The exact biases in implied standard deviations,Working Paper, VanderbiltUniversity. Dravid, Ajay R., 1984, The behavior of returnsaround ex-dates for splits and stock dividends, WorkingPaper, StanfordUniversity. of 1988, Effectsof bid-ask spreads and price discretenesson distributions stock returns, WorkingPaper, StanfordUniversity. subsequentto stock splits, David and Dan French,1985, More on the increase in volatility Dubofsky, and Texas ChristianUniversity. WorkingPaper, Texas A and M University Journal 1986, Stock splitsand impliedstockpricevolatility, Dan W. and David A. Dubofsky, French, Management12, 55-59. ofPortfolio of Mark, Ronald Masulis, and Sheridan Titman, 1984, The valuation effects stock splits Grinblatt, JournalofFinancial Economics13, 461-490. and stock dividends, Lim, Tee and Anand Vijh, 1986, The bid-ask spread and the ex-date behavior of stock splits: An using transactionsdata, WorkingPaper, Graduate School of Business, University investigation of California, Berkeley. Ohlson, James and Stephen Penman, 1985, Volatility increases subsequent to stock splits: An JournalofFinancial Economics 14, 251-266. empiricalaberration, W. Susan M. and Clifford Smith,Jr.,1980,Tradingcosts forlistedoptions:The implications Phillips, JournalofFinancial Economics8, 179-201. formarketefficiency,

1372

TheJournal Finance of

FrankK. and SandraG. Gustavson, Reilly, in on 1985,Investing options stocks announcing splits, Financial Review 121-142. 20, Roll,Richard, 1977,An analytic valuation for formula unprotected American options stocks call on with known dividends, Journal Financial of Economics 251-258. 5, Rubinstein, tests Mark, 1985, Non-parametric ofalternative models all option pricing using reported tradesand quoteson the 30 mostactiveCBOE optionclassesfrom 23, August 1976through August 1978, 31, Journal Finance40,455-480. of and Schmalensee, Richard Robert Trippi, R. stock 1978,Common volatility expectations implied by option premia, Journal Finance33, 129-147. of