Research

M. Cao and J. Wei : Commonality in Liquidity: Evidence from the Option Market

February 17, 2010

This study examines the property of liquidity in the option market. Using IvyDB’s OptionMetrics data for the period of January 1, 1996 to December 31, 2004, we establish convincing evidence of commonality in options liquidity. The commonality remains strong even after controlling for the impact of the underlying stock market and other liquidity determinants. Other findings include: 1) the stock market exhibits a much stronger commonality than does the option market, 2) compared with the inventory risk, information asymmetry plays a more dominant role in influencing options liquidity and 3) the market-wide option liquidity depends on the underlying stock market’s movements – for instance, the bid-ask spread of calls decreases (increases) when the overall market goes up (down), while that of puts takes the opposite pattern.