Stock Illiquidity, option prices, and option returns

Arbeitspapier

We provide evidence of a strong effect of the underlying stock's illiquidity on option prices by showing that the average absolute difference between historical and implied volatility increases with stock illiquidity. This pattern translates into significant excess returns of option trading strategies that are not explained by common risk factors. Simulation results show, however, that our results can be explained by the hedging costs of market makers who are net long in options on some underlyings and net short in options on other underlyings. Our empirical findings are robust with respect to the chosen illiquidity measure, the measure of option expensiveness, and the return period.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: CFR Working Paper ; No. 16-08

Classification and Topics

• Classification: Wirtschaft ; Asset Pricing; Trading Volume; Bond Interest Rates ; Contingent Pricing; Futures Pricing; option pricing
• Subject: illiquidity ; equity options ; option returns ; option strategies

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Kanne, Stefan ; Korn, Olaf ; Uhrig-Homburg, Marliese
• Event: Veröffentlichung
• (who): University of Cologne, Centre for Financial Research (CFR)
• (where): Cologne
• (when): 2016

Further information

• Handle: http://hdl.handle.net/10419/146777
• Last update: 10.03.2025, 11:45 AM CET