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The Liquidity Effect In Option Pricing: An Empirical Analysis

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  • Shih-Ping Feng

Abstract

This paper empirically examines whether asset’s liquidity can help resolve the known strike-price biases of the Black-Scholes model for different liquidity measures based on trading volume, bid-ask spread and the Amihud’s ILLIQ. Our results indicate that, when the underlying asset or its derivative exhibit lower liquidity, the degree of curvature of the strike-price biases will tend to increase, regardless of the liquidity measures used. Furthermore, inspection of 2R reveals that the stock’s liquidity has an excellent ability in explaining the strike-price biases compared with the option’s liquidity in terms of the liquidity measures based on trading volume and the Amihud’s ILLIQ.

Suggested Citation

  • Shih-Ping Feng, 2011. "The Liquidity Effect In Option Pricing: An Empirical Analysis," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 5(2), pages 35-43.
    • Handle: RePEc:ibf:ijbfre:v:5:y:2011:i:2:p:35-43
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    References listed on IDEAS

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    More about this item

    Keywords

    Option Pricing; Liquidity; Stock’s Liquidity; Option’s Liquidity; Strike-Price Biases;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • 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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