Option Market Liquidity and Stock Price Crash Risk

58 Pages Posted: 27 Jan 2023

See all articles by Min Deng

Min Deng

University of Newcastle - Newcastle University Business School

Minh Nguyen

Newcastle University Business School

Bartosz Gebka

Newcastle University Business School

Date Written: May 10, 2024

Abstract

We find that equity option liquidity increases stock price crash risk. This effect differs from the stock liquidity-crash risk causality documented elsewhere and remains robust to different measures of option liquidity and crash risk, alternative weighting schemes, option moneyness, and is not influenced by endogeneity issues. The option liquidity-stock crash risk causality is a unique phenomenon, not a manifestation of higher crash risk in times of high volatility, and is not confined to the financial crisis period. The positive impact of option liquidity on future crash risk is more apparent for firms with higher degrees of information asymmetry and for low levels of option investors' sentiment. Our results support the transient investor theory which posits that, in presence of short-term investors, managers make poor decisions and hoard subsequent bad news to avoid negative market reactions, leading to accumulation of bad news and price crashes when information is finally revealed.

Keywords: Price crash, option market, option liquidity JEL classification: G10, G11, G12

JEL Classification: G10, G11, G12

Suggested Citation

Deng, Min and Nguyen, Minh and Gebka, Bartosz, Option Market Liquidity and Stock Price Crash Risk (May 10, 2024). Available at SSRN: https://ssrn.com/abstract=4338698 or http://dx.doi.org/10.2139/ssrn.4338698

Min Deng

University of Newcastle - Newcastle University Business School ( email )

5 Barrack Road
Devonshire Building
NEWCASTLE UPON TYNE, NE1 7RU
United Kingdom

Minh Nguyen (Contact Author)

Newcastle University Business School ( email )

Newcastle upon Tyne, NE1 7RU
United Kingdom

Bartosz Gebka

Newcastle University Business School ( email )

5 Barrack Road
Newcastle, Tyne and Wear NE1 4SE
United Kingdom
+44 191 208 1578 (Phone)

HOME PAGE: http://https://www.ncl.ac.uk/business-school/staff/profile/bartoszgebka.html#background

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