The impact of liquidity on option prices

Robin K. Chou; San Lin Chung; Yu Jen Hsiao; Yaw Huei Wang

doi:10.1002/fut.20531

The impact of liquidity on option prices

Robin K. Chou, San Lin Chung, Yu Jen Hsiao, Yaw Huei Wang

Research output: Contribution to journal › Article › peer-review

19 Citations (Scopus)

Abstract

This study illustrates the impact of both spot and option liquidity levels on option prices. Using implied volatility to measure the option price structure, our empirical results reveal that even after controlling for the systematic risk of Duan and Wei (2009), a clear link remains between option prices and liquidity; with a reduction (increase) in spot (option) liquidity, there is a corresponding increase in the level of the implied volatility curve. The former is consistent with the explanation on hedging costs provided by Cetin, Jarrow, Protter, and Warachka (2006), whereas the latter is consistent with the "illiquidity premium" hypothesis of Amihud and Mendelson (1986a). This study also shows that the slope of the implied volatility curve can be partially explained by option liquidity.

Original language	English
Pages (from-to)	1116-1141
Number of pages	26
Journal	Journal of Futures Markets
Volume	31
Issue number	12
DOIs	https://doi.org/10.1002/fut.20531
Publication status	Published - Dec 1 2011
Externally published	Yes

ASJC Scopus subject areas

Accounting
Business, Management and Accounting(all)
Finance
Economics and Econometrics

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10.1002/fut.20531

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AU - Hsiao, Yu Jen

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The impact of liquidity on option prices

Abstract

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