Illiquidity Premia in the Equity Options Market

Peter Christoffersen, Ruslan Goyenko, Kris Jacobs, Mehdi Karoui
2012 Social Science Research Network  
Illiquidity is well-known to be a signi...cant determinant of stock and bond returns. We report on illiquidity premia in equity option markets. An increase in option illiquidity decreases the current option price and predicts higher expected option returns. This e¤ect is statistically and economically signi...cant. It is robust across di¤erent empirical approaches and when including various control variables. The illiquidity of the underlying stock a¤ects the option return negatively,
more » ... gatively, consistent with a hedging argument: When stock market illiquidity increases, the cost of replicating the option goes up, which increases the option price and reduces its expected return. JEL Classi...cation: G12 We would like to thank IFM 2 and SSHRC for ...nancial support. Christo¤ersen can be reached by phone at 416-946-5511 and via email to peter.christo¤ersen@rotman.utoronto.ca. Goyenko can be reached by phone on 514-398-5692 and via email to ruslan.goyenko@mcgill.ca. Jacobs can be reached by phone on 713-743-2826 and via email to kjacobs@bauer.uh.edu. Karoui can be reached by phone on 514-692-9155 and via email to mehdi.karoui@mail.mcgill.ca.
doi:10.2139/ssrn.1784868 fatcat:uadxfhupujeqncleelzz4k3k4e