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Relative option liquidity and price efficiency

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  • Brian Du

    (California State University, East Bay)

Abstract

Options trading can stimulate price efficiency in underlying stock markets by providing a platform for informed trades, increasing the production of information, and mitigating momentum arbitrage strategies and short-sale constraints. Using a large sample of 8146 firms with option trading from 1996 through 2014, this study examines the extent to which liquidity in option markets relates to the ability for stock prices to reflect all publicly available information. Variance ratio tests document that price efficiency monotonically increases across relative option liquidity deciles, proxied by the option-to-stock volume ratio, progressively becoming closer to random walk benchmarks. Evidence suggests that enhanced price efficiency is pronounced among small company stocks.

Suggested Citation

  • Brian Du, 2019. "Relative option liquidity and price efficiency," Review of Quantitative Finance and Accounting, Springer, vol. 52(4), pages 1119-1135, May.
    • Handle: RePEc:kap:rqfnac:v:52:y:2019:i:4:d:10.1007_s11156-018-0738-1
    DOI: 10.1007/s11156-018-0738-1
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    Cited by:

    1. Anagnostopoulou, Seraina C. & Trigeorgis, Lenos & Tsekrekos, Andrianos E., 2023. "Enhancement in a firm's information environment via options trading and the efficiency of corporate investment," Journal of Banking & Finance, Elsevier, vol. 149(C).
    2. Mahmoud Delshadi & Mahmoud Hosseinniakani & Zabihollah Rezaee, 2023. "Does options trading deter real activities manipulation?," Review of Quantitative Finance and Accounting, Springer, vol. 61(2), pages 673-699, August.
    3. Hao, (Grace) Qing & Li, Keming, 2022. "Options trading and earnings management: Evidence from the penny pilot program," Journal of Corporate Finance, Elsevier, vol. 77(C).
    4. Kobana Abukari & Isaac Otchere, 2020. "Has stock exchange demutualization improved market quality? International evidence," Review of Quantitative Finance and Accounting, Springer, vol. 55(3), pages 901-934, October.

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    More about this item

    Keywords

    Options; Liquidity; Price efficiency; Variance ratio;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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