Product Market Competition and Option Prices

Erwan Morellec and Alexei Zhdanov
Additional contact information
Erwan Morellec: EPFL and Swiss Finance Institute
Alexei Zhdanov: Pennsylvania State University

No 17-07, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

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.

Keywords: Product market competition; Investment; Leverage effect; Option skew (search for similar items in EconPapers)
JEL-codes: G13 G31 G32 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2017-02
New Economics Papers: this item is included in nep-com and nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1707

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