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The Price of Options Illiquidity

  • Menachem Brenner
  • Rafi Eldor
  • Shmuel Hauser

The purpose of this paper is to examine the effect of illiquidity on the value of currency options. We use a unique data set which allows us to explore this issue in special circumstances where options are issued by a central bank and are not traded prior to maturity. The value of these options is compared to similar options traded on the exchange. We find that the non-tradable options are priced about 21% less than the exchange traded options. It is an anomaly that cannot be explained by non-hedgeable risks like jumps in the prices of the liquid options which we use in replicating the payoffs of the illiquid options.

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File URL: http://www.stern.nyu.edu/fin/workpapers/papers99/wpa99086.pdf
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Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 99-086.

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Date of creation: Sep 1999
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Handle: RePEc:fth:nystfi:99-086
Contact details of provider: Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
Phone: (212) 998-0100
Web page: http://w4.stern.nyu.edu/finance/

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