THE LIQUIDITY EFFECT IN OPTION PRICING: AN EMPIRICAL ANALYSIS

Shih-Ping Feng

The International Journal of Business and Finance Research, 2011, vol. 5, issue 2, 35-43

Abstract: This paper empirically examines whether asset’s liquidity can help resolve the known strike-price biases of the Black-Scholes model for different liquidity measures based on trading volume, bid-ask spread and the Amihud’s ILLIQ. Our results indicate that, when the underlying asset or its derivative exhibit lower liquidity, the degree of curvature of the strike-price biases will tend to increase, regardless of the liquidity measures used. Furthermore, inspection of 2R reveals that the stock’s liquidity has an excellent ability in explaining the strike-price biases compared with the option’s liquidity in terms of the liquidity measures based on trading volume and the Amihud’s ILLIQ.

Keywords: Option Pricing; Liquidity; Stock’s Liquidity; Option’s Liquidity; Strike-Price Biases (search for similar items in EconPapers)
JEL-codes: G10 G12 G13 (search for similar items in EconPapers)
Date: 2011
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