Download This Paper Open PDF in Browser

How Does Stock Illiquidity Affect the Informational Role of Option Prices?

59 Pages Posted: 9 Aug 2016 Last revised: 22 Jan 2018

Luis Goncalves-Pinto

Chinese University of Hong Kong - Department of Finance

Jing Xu

Renmin University of China - School of Finance

Date Written: January 16, 2018

Abstract

We show that option prices lead stock prices because of hedging effects rather than informed trading. Theoretically, when the underlying stock is illiquid, it is more (less) costly to replicate a call compared to a put in a good (bad) market state. This creates a mechanical relation between put-call parity deviations and future stock returns. Empirically, we identify this mechanism using the short-sale ban of 2008, when banned stocks could only be shorted by option dealers for hedging purposes. We use equity lending fees and option order imbalances as proxies for short-sale costs and informed option trading, respectively.

Keywords: Put-Call Parity, Stock Return Predictability, Hedging Costs, Short-Selling

JEL Classification: G11, G12, C13

Suggested Citation

Goncalves-Pinto, Luis and Xu, Jing, How Does Stock Illiquidity Affect the Informational Role of Option Prices? (January 16, 2018). 29th Australasian Finance and Banking Conference 2016. Available at SSRN: https://ssrn.com/abstract=2820422 or http://dx.doi.org/10.2139/ssrn.2820422

Luis Goncalves-Pinto (Contact Author)

Chinese University of Hong Kong - Department of Finance ( email )

Cheng Yu Tung Building
Shatin
Hong Kong
Hong Kong

Jing Xu

Renmin University of China - School of Finance ( email )

59 Zhongguancun Street
Beijing, 100872
China

Paper statistics

Downloads
95
rank
242,111
Abstract Views
451
PlumX