Liquidity Effect in OTC Options Markets: Premium or Discount?
Indian School of Business
Case Western Reserve University - Department of Banking & Finance
Marti G. Subrahmanyam
New York University - Stern School of Business
February 2, 2010
Journal of Financial Markets, Forthcoming
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.
Number of Pages in PDF File: 49
Keywords: Liquidity, interest rate options, euro interest rate markets, Euribor market, OTC options markets
JEL Classification: G10, G12, G13, G15
Date posted: December 5, 2005 ; Last revised: August 20, 2010