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Article: Derivatives and Market (Il)liquidity
Title | Derivatives and Market (Il)liquidity |
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Authors | |
Issue Date | 1-Mar-2023 |
Publisher | Cambridge University Press |
Citation | Journal of Financial and Quantitative Analysis, 2023, v. Forthcoming How to Cite? |
Abstract | We study how derivatives (with nonlinear payoffs) affect the underlying asset’s liquidity. In a rational expectations equilibrium, informed investors expect low conditional volatility and sell derivatives to the others. These derivative trades affect different investors’ utility differently, possibly amplifying liquidity risk. As investors delta hedge their derivative positions, price impact in the underlying drops, suggesting improved liquidity, because informed trading is diluted. In contrast, effects on price reversal are ambiguous, depending on investors’ relative delta hedging sensitivity, i.e., the gamma of the derivatives. The model cautions of potential disconnections between illiquidity measures and liquidity risk premium due to derivatives trading. |
Persistent Identifier | http://hdl.handle.net/10722/328532 |
ISSN | 2023 Impact Factor: 3.7 2023 SCImago Journal Rankings: 3.980 |
DC Field | Value | Language |
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dc.contributor.author | Huang, S | - |
dc.contributor.author | Yueshen, BZ | - |
dc.contributor.author | Zhang, C | - |
dc.date.accessioned | 2023-06-28T04:45:50Z | - |
dc.date.available | 2023-06-28T04:45:50Z | - |
dc.date.issued | 2023-03-01 | - |
dc.identifier.citation | Journal of Financial and Quantitative Analysis, 2023, v. Forthcoming | - |
dc.identifier.issn | 0022-1090 | - |
dc.identifier.uri | http://hdl.handle.net/10722/328532 | - |
dc.description.abstract | We study how derivatives (with nonlinear payoffs) affect the underlying asset’s liquidity. In a rational expectations equilibrium, informed investors expect low conditional volatility and sell derivatives to the others. These derivative trades affect different investors’ utility differently, possibly amplifying liquidity risk. As investors delta hedge their derivative positions, price impact in the underlying drops, suggesting improved liquidity, because informed trading is diluted. In contrast, effects on price reversal are ambiguous, depending on investors’ relative delta hedging sensitivity, i.e., the gamma of the derivatives. The model cautions of potential disconnections between illiquidity measures and liquidity risk premium due to derivatives trading. | - |
dc.language | eng | - |
dc.publisher | Cambridge University Press | - |
dc.relation.ispartof | Journal of Financial and Quantitative Analysis | - |
dc.title | Derivatives and Market (Il)liquidity | - |
dc.type | Article | - |
dc.identifier.doi | 10.1017/S0022109023000224 | - |
dc.identifier.hkuros | 344604 | - |
dc.identifier.volume | Forthcoming | - |
dc.identifier.eissn | 1756-6916 | - |
dc.identifier.issnl | 0022-1090 | - |