The Price of Options Illiquidity
18 Pages Posted: 1 Jan 2014
Date Written: April 2001
The purpose of this paper is to examine the effect of illiquidity on the value of currency options. We use a unique dataset that allows us to explore this issue in special circumstances where options are issued by a central bank and are not traded prior to maturity. The value of these options is compared to similar options traded on the exchange. We find that the non-tradable options are priced about 21 percent less than the exchange-traded options. This gap cannot be arbitraged away due to transactions costs and the risk that the exchange rate will change during the bidding process.
Keywords: Options, Liquidity, Non-tradable
JEL Classification: G12, G14, D23
Suggested Citation: Suggested Citation