Product Market Competition and Option Prices
64 Pages Posted: 17 Feb 2017 Last revised: 29 Jun 2017
Date Written: June 28, 2017
Most firms face some form of competition in product markets. The degree of competition a firm faces feeds back into its cash flows and affects the values of the securities it issues. We demonstrate that, through its effects on stock prices, product market competition also affects the prices of options on equity and naturally leads to an inverse relationship between equity returns and volatility, generating a negative volatility skew in option prices. Using a large sample of U.S. equity options, we provide empirical support for this finding and demonstrate the importance of accounting for product market competition when explaining the cross-sectional variation in option skew.
Keywords: Product market competition, Investment, Leverage effect, Option skew
JEL Classification: G13, G31, G32
Suggested Citation: Suggested Citation