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Stock illiquidity and option returns

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  • Kanne, Stefan
  • Korn, Olaf
  • Uhrig-Homburg, Marliese

Abstract

We provide evidence of a strong effect of the underlying stock's illiquidity on option returns. Conditional on end-user demand, illiquidity premiums are negative and decrease in stock illiquidity for options where end users are net buyers, while premiums are positive and tend to increase otherwise. Our results cannot be explained by common risk factors and cross-sectional differences in stock volatility or option spreads and are robust to different illiquidity measures and data periods. The observed pattern is consistent with an intermediary hedging cost channel and the magnitudes of our illiquidity premiums are in line with reasonable transaction costs.

Suggested Citation

  • Kanne, Stefan & Korn, Olaf & Uhrig-Homburg, Marliese, 2023. "Stock illiquidity and option returns," Journal of Financial Markets, Elsevier, vol. 63(C).
    • Handle: RePEc:eee:finmar:v:63:y:2023:i:c:s1386418122000556
    DOI: 10.1016/j.finmar.2022.100765
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    1. Ma, Pengcheng & Taghipour, Mehran & Cattani, Carlo, 2024. "Option pricing in the illiquid markets under the mixed fractional Brownian motion model," Chaos, Solitons & Fractals, Elsevier, vol. 182(C).

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    More about this item

    Keywords

    Illiquidity; Equity options; Option returns; Hedging costs;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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