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Illiquidity Premia in the Equity Options Market

Author

Listed:
  • Peter Christoffersen

    (University of Toronto - Rotman School of Management and CREATES)

  • Ruslan Goyenko

    (McGill University - Faculty of Management)

  • Kris Jacobs

    (University of Houston - C.T. Bauer College of Business)

  • Mehdi Karoui

    (McGill University)

Abstract
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 effect is statistically and economically signi?cant. It is robust across different empirical approaches and when including various control variables. The illiquidity of the underlying stock affects the option return negatively, 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.

Suggested Citation

  • Peter Christoffersen & Ruslan Goyenko & Kris Jacobs & Mehdi Karoui, 2011. "Illiquidity Premia in the Equity Options Market," CREATES Research Papers 2011-43, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:create:2011-43
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    References listed on IDEAS

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    More about this item

    Keywords

    illiquidity; equity options; cross-section; option returns; option smile.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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