Time-varying Crash Risk Embedded in Index Options: The Role of Stock Market Liquidity

Peter Christoffersen, Bruno Feunoua, Yoontae Jeon, Chayawat Ornthanalai

Research output: Working paperResearch

Abstract

We estimate a continuous-time model with dynamic crash probability using the S&P500 index options and high-frequency information. We find that market illiquidity is an important factor in explaining the time-varying stock market crash risk embedded in index options. While market illiquidity and return volatility play complementary roles in explaining the time-varying crash risk, the relative contribution of the volatility factor is weakened once we include market illiquidity as an economic variable. Examining the link between market illiquidity and option-implied crash risk, we find that the availability of arbitrage capital and adverse selection facing liquidity providers are economic driving forces.
Original languageEnglish
Place of PublicationToronto
PublisherRotman School of Management, University of Toronto
Number of pages15
DOIs
Publication statusPublished - 24 Jul 2018
SeriesRotman School of Management Working Paper
Number2797308

Keywords

  • Market liquidity
  • Crash risk
  • Jump intensity
  • Options
  • Filtering

Cite this

Christoffersen, P., Feunoua, B., Jeon, Y., & Ornthanalai, C. (2018). Time-varying Crash Risk Embedded in Index Options: The Role of Stock Market Liquidity. Rotman School of Management, University of Toronto. Rotman School of Management Working Paper, No. 2797308 https://doi.org/10.2139/ssrn.2797308