Option Implied Liquidity and Stock Returns

49 Pages Posted: 16 Oct 2017 Last revised: 11 May 2019

See all articles by Minh Nguyen

Minh Nguyen

Newcastle University Business School

Yuanyu Yang

University of Newcastle - Business School

Date Written: May 9, 2019

Abstract

This study examines a market-wide liquidity measure based on the systematic deviations from Put-Call parity in the U.S. equity option markets. We show that this implied liquidity measure provides forward-looking information about market returns and significantly explains the cross-sectional variations of stock returns. We show that investing in the stocks with the largest exposure to the innovations in the implied liquidity and shorting the stocks with the smallest generate significant returns of about 7.3 percent per annum. The explanatory power of implied liquidity for the cross-sectional variations of stock returns remain robust after controlling for various liquidity influences, the short-selling constraints and the effects of information asymmetry.

Keywords: Il-liquidity, Asset pricing, Return predictability

JEL Classification: G10; G11; G12

Suggested Citation

Nguyen, Minh and Yang, Yuanyu, Option Implied Liquidity and Stock Returns (May 9, 2019). Available at SSRN: https://ssrn.com/abstract=3053462 or http://dx.doi.org/10.2139/ssrn.3053462

Minh Nguyen (Contact Author)

Newcastle University Business School ( email )

Newcastle upon Tyne, NE1 7RU
United Kingdom

Yuanyu Yang

University of Newcastle - Business School ( email )

Newcastle upon Tyne, NE1 7RU
United Kingdom

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