Relative option liquidity and price efficiency

Brian Du ()
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Brian Du: California State University, East Bay

Review of Quantitative Finance and Accounting, 2019, vol. 52, issue 4, No 8, 1119-1135

Abstract: Abstract Options trading can stimulate price efficiency in underlying stock markets by providing a platform for informed trades, increasing the production of information, and mitigating momentum arbitrage strategies and short-sale constraints. Using a large sample of 8146 firms with option trading from 1996 through 2014, this study examines the extent to which liquidity in option markets relates to the ability for stock prices to reflect all publicly available information. Variance ratio tests document that price efficiency monotonically increases across relative option liquidity deciles, proxied by the option-to-stock volume ratio, progressively becoming closer to random walk benchmarks. Evidence suggests that enhanced price efficiency is pronounced among small company stocks.

Keywords: Options; Liquidity; Price efficiency; Variance ratio (search for similar items in EconPapers)
JEL-codes: G01 G13 G14 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (5)

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DOI: 10.1007/s11156-018-0738-1

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