The impact of liquidity on option prices |
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| Authors: | Robin K Chou San‐Lin Chung Yu‐Jen Hsiao Yaw‐Huei Wang |
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| Institution: | 1. Department of Finance and Risk and Insurance Research Center, National Chengchi University, Taipei, Taiwan;2. Department of Finance, National Taiwan University, Taipei, Taiwan;3. Department of Finance, National Central University, Jhongli, Taiwan |
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| 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. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark |
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