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Product Market Competition and Option Prices

64 Pages Posted: 17 Feb 2017 Last revised: 29 Jun 2017

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Alexei Zhdanov

Pennsylvania State University

Date Written: June 28, 2017

Abstract

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

Morellec, Erwan and Zhdanov, Alexei, Product Market Competition and Option Prices (June 28, 2017). Swiss Finance Institute Research Paper No. 17-07. Available at SSRN: https://ssrn.com/abstract=2919354 or http://dx.doi.org/10.2139/ssrn.2919354

Erwan Morellec (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

College of Management
Extranef Quartier UNIL-Dorigny
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Alexei Zhdanov

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

HOME PAGE: http://www.alexeizhdanov.com

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