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Liquidity effect in OTC options markets: Premium or discount?

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  • Deuskar, Prachi
  • Gupta, Anurag
  • Subrahmanyam, Marti G.

Abstract

Can the liquidity premium in asset prices, as documented in the exchange-traded equity and bond markets, be generalized to the over-the-counter (OTC) derivative markets? Using OTC euro ([euro]) interest rate cap and floor data, we find that illiquid options trade at higher prices relative to liquid options. This liquidity discount, though opposite to that found in equities and bonds, is consistent with the structure of this OTC market and the nature of its demand and supply forces. The results suggest that the effect of liquidity on asset prices cannot be generalized without regard to the characteristics of the market.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Markets.

Volume (Year): 14 (2011)
Issue (Month): 1 (February)
Pages: 127-160

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Handle: RePEc:eee:finmar:v:14:y:2011:i:1:p:127-160

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Web page: http://www.elsevier.com/locate/finmar

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Keywords: Liquidity Interest rate options Euro interest rate markets Euribor market OTC options markets;

References

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Citations

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Cited by:
  1. Massimiliano Caporin & Angelo Ranaldo & Paolo Santucci de Magistris, 2011. "On the Predictability of Stock Prices: A Case for High and Low Prices," "Marco Fanno" Working Papers 0136, Dipartimento di Scienze Economiche "Marco Fanno".
  2. Loon, Yee Cheng & Zhong, Zhaodong Ken, 2014. "The impact of central clearing on counterparty risk, liquidity, and trading: Evidence from the credit default swap market," Journal of Financial Economics, Elsevier, Elsevier, vol. 112(1), pages 91-115.
  3. Peter Christoffersen & Ruslan Goyenko & Kris Jacobs & Mehdi Karoui, 2013. "Illiquidity Premia in the Equity Options Market," CREATES Research Papers 2013-48, School of Economics and Management, University of Aarhus.
  4. Karnaukh, Nina & Ranaldo, Angelo & Söderlind, Paul, 2013. "Understanding FX Liquidity," Working Papers on Finance 1315, University of St. Gallen, School of Finance.
  5. Szu, Wen-Ming & Wang, Ming-Chun & Yang, Wan-Ru, 2011. "The determinants of exchange settlement practices and the implication of volatility smile: Evidence from the Taiwan Futures Exchange," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 826-838, October.

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