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Product Market Competition and Option Prices

Author

Listed:
  • Erwan Morellec

    (EPFL and Swiss Finance Institute)

  • Alexei Zhdanov

    (Pennsylvania State University)

Abstract

Most firms face some form of competition in product markets. The degree of competition a firm faces feeds back into its cash flows and affects the values of the securities it issues. We demonstrate that, through its effects on stock prices, product market competition also affects the prices of options on equity and naturally leads to an inverse relationship between equity returns and volatility, generating a negative volatility skew in option prices. Using a large sample of U.S. equity options, we provide empirical support for this finding and demonstrate the importance of accounting for product market competition when explaining the cross-sectional variation in option skew.

Suggested Citation

  • Erwan Morellec & Alexei Zhdanov, 2017. "Product Market Competition and Option Prices," Swiss Finance Institute Research Paper Series 17-07, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1707
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    More about this item

    Keywords

    Product market competition; Investment; Leverage effect; Option skew;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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