Liquidity Effect in OTC Options Markets: Premium or Discount?

49 Pages Posted: 5 Dec 2005 Last revised: 20 Aug 2010

Prachi Deuskar

Indian School of Business

Anurag Gupta

Case Western Reserve University - Department of Banking & Finance

Marti G. Subrahmanyam

New York University - Stern School of Business

Date Written: February 2, 2010

Abstract

Can the liquidity premium in asset prices, as documented in the exchange-traded equity and bond markets, be generalized to the over-the-counter (OTC) derivative markets? Using OTC euro (€) interest rate cap and floor data, we find that illiquid options trade at higher prices relative to liquid options. This liquidity discount, though opposite to that found in equities and bonds, is consistent with the structure of this OTC market and the nature of its demand and supply forces. Our results suggest that the effect of liquidity on asset prices cannot be generalized without regard to the characteristics of the market.

Keywords: Liquidity, interest rate options, euro interest rate markets, Euribor market, OTC options markets

JEL Classification: G10, G12, G13, G15

Suggested Citation

Deuskar, Prachi and Gupta, Anurag and Subrahmanyam, Marti G., Liquidity Effect in OTC Options Markets: Premium or Discount? (February 2, 2010). Journal of Financial Markets, Forthcoming. Available at SSRN: https://ssrn.com/abstract=923905

Prachi Deuskar

Indian School of Business ( email )

Hyderabad, Gachibowli 500 019
India

Anurag Gupta (Contact Author)

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-2938 (Phone)
216-368-4776 (Fax)

Marti G. Subrahmanyam

New York University - Stern School of Business ( email )

Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)

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