Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/146777
Authors: 
Kanne, Stefan
Korn, Olaf
Uhrig-Homburg, Marliese
Year of Publication: 
2016
Series/Report no.: 
CFR Working Paper 16-08
Abstract: 
We provide evidence of a strong effect of the underlying stock's illiquidity on option prices by showing that the average absolute difference between historical and implied volatility increases with stock illiquidity. This pattern translates into significant excess returns of option trading strategies that are not explained by common risk factors. Simulation results show, however, that our results can be explained by the hedging costs of market makers who are net long in options on some underlyings and net short in options on other underlyings. Our empirical findings are robust with respect to the chosen illiquidity measure, the measure of option expensiveness, and the return period.
Subjects: 
illiquidity
equity options
option returns
option strategies
JEL: 
G12
G13
Document Type: 
Working Paper

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