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Liquidity effect in OTC options markets: Premium or discount?

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

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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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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