The Trade-Off Between Liquidity and Precision of Position in Option Contracts

Koch, Alexander K.; Lazarov, Zdravetz

doi:10.2139/ssrn.302654

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The Trade-Off Between Liquidity and Precision of Position in Option Contracts

Review of Applied Economics, Vol. 3, No. 1-2, pp. 25-48, 2007

33 Pages Posted: 8 Mar 2002 Last revised: 16 Oct 2008

See all articles by Alexander K. Koch

Alexander K. Koch

University of Aarhus - Department of Economics and Business Economics; IZA Institute of Labor Economics

Zdravetz Lazarov

Bonn Graduate School of Economics

Date Written: October 15, 2007

Abstract

More liquid financial contracts are claimed to draw trading volume from contracts for which they are close substitutes. We provide the first analysis of how trading volume across existing financial contracts is affected by changes in the factors that govern the degree to which they are substitutes. Using data on DAX options with different strike prices, we identify these factors and their impact on the distribution of trades across contracts. The results are relevant for exchange design since they help gauge when options with different strike prices are good (bad) substitutes and the strike price grid should be coarse (fine).

Keywords: Clustering, Exchange Design, Options

JEL Classification: G10, G20, L15

Suggested Citation: Suggested Citation

Koch, Alexander K. and Lazarov, Zdravetz, The Trade-Off Between Liquidity and Precision of Position in Option Contracts (October 15, 2007). Review of Applied Economics, Vol. 3, No. 1-2, pp. 25-48, 2007, Available at SSRN: https://ssrn.com/abstract=302654 or http://dx.doi.org/10.2139/ssrn.302654