Work

Illiquidity and Higher Cumulants

Year: 2022

Type: article

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.

Source: Review of Financial Studies

DOI: 10.1093/rfs/hhac069

Authors: Sergei Glebkin, Semyon Malamud, Alberto Teguia

Institutions: INSEAD, École Polytechnique Fédérale de Lausanne, Swiss Finance Institute

Language: English

Topic: Stochastic processes and financial applications

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

Funders: Swiss Finance Institute, Schweizerischer Nationalfonds zur Förderung der Wissenschaftlichen Forschung

Award: International Macroeconomics With Financial Frictions