A dark side to options trading? Evidence from corporate default risk

Haoyi Yang () and Shikong Luo ()
Additional contact information
Haoyi Yang: Nanjing University
Shikong Luo: The University of Oklahoma

Review of Quantitative Finance and Accounting, 2023, vol. 60, issue 2, No 5, 564 pages

Abstract: Abstract Does options trading increase or decrease corporate default risk? We answer this question by examining how options trading affects the expected default frequency. The results reveal a positive correlation between equity options trading and future corporate default risk. A single-standard-deviation increase in options trading volume is associated with an increase of over 3% in the expected default probability. Using actual defaults as well as the CDS spread as an alternative proxy for default risk yields consistent results. To corroborate this evidence, we use several econometric specifications, including instrumental variables and the Penny Pilot Program of the Chicago Board Options Exchange as an exogenous shock for the quasi-natural experiment. Moreover, the positive effect of options trading on default risk is more pronounced when firms are more financially distressed and when the CEO holds a smaller stake of inside debt. Further evidence suggests that options trading induces excessive corporate risk-taking activities that destroy firm value and increases CEO compensation convexity. Overall, the results are consistent with an active options market increasing firm default risk by inducing excessive shifting of risk.

Keywords: Options trading; Default risk; Penny Pilot Program (search for similar items in EconPapers)
JEL-codes: G1 G33 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s11156-022-01110-7 Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:rqfnac:v:60:y:2023:i:2:d:10.1007_s11156-022-01110-7

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/11156/PS2

DOI: 10.1007/s11156-022-01110-7

Access Statistics for this article

Review of Quantitative Finance and Accounting is currently edited by Cheng-Few Lee

More articles in Review of Quantitative Finance and Accounting from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().