Option Implied Liquidity and Stock Returns
49 Pages Posted: 16 Oct 2017 Last revised: 11 May 2019
Date Written: May 9, 2019
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: Suggested Citation