Illiquidity and Higher Cumulants

Sergei Glebkin, Semyon Malamud and Alberto Teguia

The Review of Financial Studies, 2023, vol. 36, issue 5, 2131-2173

Abstract: We characterize the unique equilibrium in an economy populated by strategic CARA investors who trade multiple risky assets with arbitrarily distributed payoffs. We use our explicit solution to study the joint behavior of illiquidity of option contracts. Option bid-ask spreads are proportional to risk aversion and risk-neutral variances of option payoffs. Spreads may decrease in risk aversion, physical variance, open interest, and increase after earnings announcements in a result contrary to conventional wisdom. All these predictions are confirmed empirically using a large panel data set of U.S. stock options.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

JEL-codes: D21 G31 G32 G35 L11 (search for similar items in EconPapers)
Date: 2023
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